469C Bukit Timah Road Singapore 259772 Tel: (65) 6516 6134 Fax: (65) 6778 1020 Website: www.lkyspp.nus.edu.sg

Conceptualizing, Analyzing and Measuring Political Risk: The Evolution of Theory and Method

Darryl S.L. Jarvis Associate Professor

Lee Kuan Yew School of Public Policy National University of Singapore Email: Darryl.Jarvis@nus.edu.sg

Abstract

This article analyses the concept of political risk, its evolution and conceptualization, and explores its utility as a means of understanding political events and processes that can threaten order, stability and continuity in International Relations and disrupt the normal practices of inter-state investment, trade and commerce. More particularly, the article organizes the disparate literature that surrounds the concept of political risk such that it might be more rigorously applied as a social science method for understanding political events and their effects upon commercial and strategic activities.

Key Words: Political Risk, Political Risk theory, investment risk, political risk measurement, political risk analysis

1 | P a g e

Introduction

The study of political risk comprises a seemingly perennial body of literature that has

boomed and waned in concert with events in the international political economy (see

chapter 5). The ebbs and flows that comprise interest in the subject as well as attempts to

theorize and conceptually map its contours, dominant features and methods for its

management and mitigation, have thus been episodic. Students of political risk will thus

have difficulty in identifying a linear genealogy of theory, models and conceptual

frameworks of analysis. At one and the same time studies of political risk represent a

nascent area of inquiry and an established feature of the international arena.

This chapter explores this conundrum first by attempting to define the constitutive

elements that comprise political risk, or at least identify the ontologies that comprise its

causal agents, and second by attempting to canvas the dominant strands of theorizing and

conceptual designs that have arisen to identify, analyze and measure political risk. As this

chapter also demonstrates, however, both these tasks are fraught with ambiguity. In the

first instance, defining political risk proves an elusive task if approached as a deductive-

typological exercise, most obviously because its genealogy is discursive, its

epistemology situated between disciplines rather than within a singular discipline, and

because the generative agents of political risk are heterogeneous. For that reason, the

chapter suggests that political risk is best approached as a praxis driven ontology and

defined in relation to it its practical applications. Second, as the remainder of the chapter

demonstrates, identifying distinct schools of thought and bodies of theory, while a

necessary heuristic and pedagogical device, probably imposes greater order and clarity on

political risk theorizing and methodological innovation than has existed in practice. Most

methodological and theoretical approaches to political risk analysis have been discursive

and discrete, emblematic of the episodic interest in the area and discipline based research

approaches that have tended to produce scattered clusterings of theory. Connecting these

in ways that allow systemic examination and critique is thus one of the primary

objectives of this chapter.

2 | P a g e

Etiology, Epistemology and Definition

By virtue of both its subject mater and the objects of its inquiry, political risk strides

across numerous disciplines. While not the exclusive focus of their subject matter, to

varying degrees scholars concerned with developmental politics and economics, political

economists concerned with the issues of trade, investment and the activities of

multinational enterprise, and students of international business exploring risk and risk

exposure and its effects upon the activities of firms, have all grappled with the problem of

political risk.1 Its subject matter can thus rightly be claimed by political science,

development studies, international relations, international business, economics, and

economic geography ―― a feature which has undoubtedly been the principal reason

hindering its theoretical consolidation and advancement.

Defining political risk is thus wrought with danger and more accurately a function of

disciplinary perspective than objective statement. For students of international business,

for example, it reflects a concern with the management of exogenous factors that can

influence market conditions. As Llewellyn D. Howell notes, “. . . ’political risk' refers to

the possibility that political decisions or events in a country will affect the business

climate in such a way that investors will lose money or not make as much money as they

expected when the investment was made.”2 The objective of political risk analysis is thus

clear: “an effort to project ‘harm’ to the investor by political forces or . . . from political

decisions.” For Howell, it involves an analysis of history or current events that might lead

to a “projection of circumstances under which harm occurs. The purpose of making such

a projection is to prepare the investor for dealing with such risks.”3

1 See, for example, Robock, S.H., (1971), “Political Risk Identification and Assessment,” Columbia Journal of World Business, 6(4), pp.6-20; Robock, S.H., & Simmonds, K., (1989), International Business and Multinational Enterprise. Richard D. Irwin: Boston; Herring, R.J., (1983)(ed.), Managing International Risk. Cambridge: Cambridge University Press; Flyvbjerg, B., Bruzelius, N., & Roteengatter, W., (2003), Megaprojects and Risk: An Anatomy of Ambition. Cambridge: Cambridge University Press; Lax, H.L., (1983), Political Risk in the International Oil and Gas Industry. International Human Resources Development Corporation: Boston. 2 Llewellyn D. Howell (1994), “An Introduction to Country and Political Risk Analysis,” in William D. Coplin and Michael K. O'Leary (eds.), The Handbook of Country and Political Risk Analysis. Syracuse, New York. Political Risk Services, p.1. 3 ibid.,p.1.

3 | P a g e

Similarly, David Schmidt defines political risk as “the application of host government

policies that constrain the business operations of a given foreign investment.” For

Schmidt, political risk is divisible into three sub-categories: “transfer risk,” defined as

risk to capital payments or profit repatriation; “operational risk,” referring to issues

surrounding local sourcing and content or production / business continuity; “ownership

control risk,” referring to issues concerning expropriation or confiscation.4 Charles

Kennedy concurs, albeit more broadly and defines political risk as a strategic, financial or

personal loss to a firm because of non-market events or factors that effect the macro-

economic and macro-political climate. 5 These, he notes, can stem from numerous

sources and affect the fiscal, monetary, trade, investment, labor, industrial and

developmental climate of a host country, adversely impacting the profitability, life

expectancy, viability, or legal ownership status of the investment.6 Political risk in this

context can emerge from the orderly activities of governments, regulatory agencies or

judiciaries, and which effect market conditions or macro-economic / macro-political

circumstances. Equally, however, they can arise from dysfunctional political events like

terrorism, coups, riots, insurrection, secessionism, civil war, or by violet political

contestation ―― forces, in other words, that pervert the operation of normal political

processes.

For political scientists, by contrast, definitions of political risk tend to rest with the

exercise of power and the harm that can stem from this to individuals, populations,

nation-states and the international system. The exercise of power for nefarious ends, the

use of force and armed aggression, or the making of war, are thus, by definition, both the

objects of study and the subject of inquiry. Political risk is thus broadly understood to

4 David Schmidt as quoted in Robert Poirier (1997), “Political Risk Analysis and Tourism,” Annals of Tourism Research, 24(3), p.667. See also David A. Schmidt (1986), “Analyzing Political Risks,” Business Horizons, 29(4), pp.43-60. 5 Charles R. Kennedy (1988), “Political Risk Management: A Portfolio Planning Model,” Business Horizons, 31(6), pp.26-33. 6 Jung Hwa Hong, Peter Jones and Haiyan Song (1999), “Political Risk and Foreign Investment Decision of International Hotel Companies,” First Pan-American Conference, Latin American Tourism in the Next Millennium: Education, Investment and Sustainability < http://www.hotel-online.com/Neo/Trends/PanAmerProceedingsMay99/PolRiskInvestHotels.html> accessed on October 19, 2004.

4 | P a g e

include those factors and or processes that might hinder, constrain or obviate the

operation of political institutions, the exercise of legitimate rule and the functioning of

civil (domestic) and international society. Political risk represents any threat to the

peaceful coexistence between states, the orderly administration of a national polis, or to

the supplanting of legitimate, orderly, peaceable rule by armed, aggressive, illegitimate,

anarchy. For political scientists, political risk is thus most often read as political

instability, where order at either the international or domestic level is replaced by chaos

or where certainty in public rule and the discharge of political power becomes

unpredictable. Acute political risk is therefore often associated with inter-state warfare,

revolution, civil war and state-failure, while less acute forms of political risk at the

international level are generally associated with diplomatic hostility, cold wars,

isolationism, mercantilism and trade wars, and at the domestic level with civil

disobedience, low government legitimacy, poor levels of public probity or with impaired

public administration.7

For students of political modernization and development, on the other hand, political risk

is normally defined in relation to the maturity, transparency and the capacity of state

based political institutions to effectively administrate the needs of the national polis,

adjudicate and balance the interests and demands of competing constituencies, the

independence of statutory bodies like the judiciary, the probity of financial and economic

administration of national accounts, and the transparency of electoral systems. State and

institutional / administrative capacity combined with levels of transparency and probity

are thus most commonly invoked to assess political risk ―― most obviously in

developing and transition economies where the costs of corruption, nepotism,

dysfunctional public policy and biased judicial rulings can be a burden on economic

actors and or impede the efficient functioning of the economic system.8 Political risk in

7 See, for example, Martin Jänicke (1990), State Failure: The Importance of Politics in Industrial Society. Pennsylvania State University Press; Jennifer Milliken (2003), State Failure, Collapse and Reconstruction. Oxford: Blackwell Publishers. 8 A survey of 3951 firms in 74 countries, for example, discovered that corruption and judicial unpredictability were the second and third most serious obstacles to doing business (after taxation), while a similar survey of the largest MNEs found that political risks like corruption, nepotism and crony capitalism cost firms over US$24 billion in lost revenues in 1998. See Witold J. Heniz and Bennet A. Zelner (2003), “The Strategic Organization of Political Risks and Opportunities,” Strategic Organization, 1(4), p.452.

5 | P a g e

this context is again most usually invoked in relation to end users like economic actors,

where the consequence of inefficient or corrupt administration is calculated in terms of its

costs to business, investment and economic growth.

On another level, however, political risk is often approached as simply the activities of

governments (and or its agencies) whose decisions, policies, edicts and rulings create

outcomes that distort, impact, change or adversely effect the interests of stakeholders

(economic and non-economic actors). Change in any political parameter that has

ramifications for stakeholders in the affected policy area is thus defined as political risk.

On this reading, political risk is a function of governmental activity and or inactivity to

effect desired policy change, and a problem equally experienced by developed and

developing societies. It is this form of political risk that is commonly associated with the

study of public policy and around which extensive lobbying activities by business

organizations and special interest groups occurs. The importance of this form of political

risk is revealed in the length various organizations like corporations go to avert exposure

to adverse public policy. In the United States alone, for example, estimates of spending

on corporate lobbying activities exceed US$30 billion annually and employs an estimated

16,000 full-time lobbyists in Washington, DC who campaign for corporate interests in

policy areas that range from defense, telecommunications, media, public liability and

consumer protection laws, aviation, agriculture, and construction ―― to name but a few.

Across the Atlantic at the European Union headquarters in Brussels, Belgium, a further

10,000 full-time lobbyists reflecting an equally diverse range of corporate and special

interests campaign on behalf of their constituents, again devoting tens of billions of euros

to insure desired policy outcomes.9 The commitment of such extensive and on-going

resources testifies to the importance of the policy environment and the sensitivity of both

business and non-business groups to political risk from policy changes and or policy

inactivity.

Political Risk Defined as Praxis Driven Ontology

9 ibid.

6 | P a g e

As the above few examples highlight, definitions of political risk are more gainfully

derived in relation to the proscribed utility of their application and praxis rather than any

objective-universal criteria. Most political risk analysis, for example, is done for practical

reasons; as part of developmental discourse and analysis to build institutional capacity,

improve public administration, probity, transparency and increase the efficiency and

delivery outcomes of public administration in order to provide the necessary institutional

environment for economic growth and the eradication of poverty; to apprise concerned

economic actors of the consequences of policy outcomes and or policy inaction; to help

organizations lobby government to amend, change or reverse public policy deemed

inappropriate or detrimental to their constituent interests; to help business organizations

manage their investment exposures in foreign political environments; to understand,

prepare for and or mitigate the consequences of governmental actions and public policy

on the market parameters in which stakeholders have a vested interest; and to manage the

vagaries of governmental, judicial, and statutory body rulings and their perceived

consequences for stakeholders (see Figure 1.1).

7 | P a g e

Figure 1.1

Political Risk Typology Defined by Praxis Ontology

Praxis Area Description of

Praxis

Application

Level(s) of

Analysis

Assumed

Dominant Risk

Drivers /

Actors / Agents

/ & Processes

Major End

Users

International

Business Risk

Analysis

Country risk

analysis /

macro-

economic and

macro-political

forecasts /

project based

risk assessment

/ share holder

due diligence

reports/ legal

liability &

indemnity

assessment

International,

domestic, sub-

national, local,

project based,

individuals

Government and

quasi

government

agencies /

regulatory and

statutory bodies/

judiciary / legal

system/

bankruptcy

protection laws

/corruption /

cronyism /

nepotism / JV

partner(s) /

policy continuity

/ political

stability / civil

unrest /

governmental

transparency /

MNEs, banks,

fund managers,

credit ratings

agencies,

forecasters,

insurance

underwriters,

foreign direct

investors

Public Sector

Risk Analysis

Institutional

analysis /

institutional

capacity

Domestic

(national) /

sub-national

actors –

Adequacy of

institutional

capacity / policy

formation and

Government /

Public sector

agencies /

international

8 | P a g e

building/

institutional

development

and innovation /

public sector

efficiency

enhancement

/public sector

outcomes

enhancement

/regulatory

management

/prudential

reform / costing

and efficiency

analysis

statutory bodies

/ quasi-

government

agencies /

regulatory

authorities

assessment

process /

institutional

resource

availability /

level of probity

and institutional

transparency

/institutional

accountability

mechanisms

/independence

of statutory

bodies /

extensity of

political bias,

political

patronage,

nepotism

/human resource

and skill

capacity / extent

of institutional

learning and

adaptability

development

agencies (IMF,

World Bank,

International

Financial

Corporation,

Asian

Development

Bank, OECD,

etc.) / NGOs /

citizens groups

and not for

profit watch

dogs

Policy Risk

Analysis

Policy

implications for

stakeholders

/impact

assessments /

Predominantly

domestically

focused but

some

internationally

Policy

implementation

processes and

mechanisms /

political and

Lobby groups /

special interest

groups /

political action

committees /

9 | P a g e

industry

position papers /

market – sector

– industry

composition

analysis /

projection

analysis

focused (e.g.,

trade and

finance issues)

institutional

decision makers

/ relevant

regulatory

agencies or

oversight

committees

industry &

consumer

groups

International

Risk Analysis

Threat

assessments and

projections/

economic

security

assessment /

intelligence

assessments /

terrorist analysis

/ humanitarian

crisis

assessment /

international

crisis

management /

security and

defense

assessment /

defense,

security and

foreign policy

planning and

positioning

Global,

regional,

international

and domestic

and sub-

national

Nation-states

/rogue states /

sub-national

actors like

terrorists and

terrorist

networks,

separatist

movements,

transnational

and domestic

criminal

networks /

political

instability / civil

war / coups /

military and

civilian

dictatorship

Government

and

government

agencies / law

enforcement

agencies /

political

scientists /

defense

planners /

intelligence

agencies /

armed forces /

NGOs / foreign

policy decision

makers /

advocacy

groups and

think tanks

10 | P a g e

strategies

11 | P a g e

Defining political risk as a praxis driven ontology thus helps reveal much about its

current applications and with this many of its dominant assumptions, frameworks of

analysis and the object(ive)s of its study. Importantly, for example, it alerts us to the fact

that despite the discrete nature of their praxis applications the methodological

frameworks of inquiry used in political risk analysis tend to fuse around common themes:

that is, the objects and subjects of political risk analysis are mostly contiguous while the

objectives and purposes for which they are analyzed vary (this is graphically represented

in Figure 1.2). Viewed in this way, the confusion that sometimes surrounds the myriad

ways that political risk appears to be defined or analyzed, in fact reflects no more than its

utilization by multifarious end-users (development economists, political scientists,

international business analysts, risk managers in MNEs, economists, etc). Rather than

discord or dissonance in terms of the objects of study, political risk analysis reflects a

relatively stable focal plane defined by concerns with political system, political stability,

policy continuity and change, institutional stability and probity, the rule of law,

governance and transparency. These themes run throughout the literature on political risk

and are only separated by degrees of emphasis and methodological difference in terms of

assessment, weighting and measurement systems.

Second, a praxis driven definition tells us why approaches to the study and analysis of

political risk must necessarily be interdisciplinary; drawing upon various analytical and

theoretical traditions in ways that intermediate the political, economic and social

dimensions of political institutions and their functioning, political systems and their

constituents, and economic systems and their actors. In other words, the analytical

dimensions of political risk analysis necessarily breakdown the artificial definitional

parameters that separate social influences and process from economic and political

influences and processes. The bounded rationality of markets suggested by economists,

for example, is not assumed in political risk analysis since politics is acknowledged as

prescient to markets and thus the quasi-mechanism / process that defines market

extensity, transparency, competition and thus the rules of commercial engagement and

the functioning of the economic system.

12 | P a g e

Third, a praxis based understanding of political risk alerts to the fact that interest in the

subject and motivation for its investigation has been spurned by practical demands. While

various forms of domestic institutional and policy risk analysis have tended to be at least

informally present in developed and many emerging states for the greater part of their

existence, the formalization of this has been a function of the consolidation of

government as a centralized institutional feature of modern states. The institutional reach

of government and the expansion of state apparatus among modern Western states since

the ending of the Second World War, for example, has witnessed enormous growth in the

state’s economic role (accounting for upwards of one third of GNP in OECD states), but

especially in its welfare and regulatory reach into virtually every facet of political,

economic and social activity. As a consequence, institutional and policy risk analysis has

likewise grown and been increasingly formalized reflecting the desire to understand and

anticipate the consequences of governmental policy activity on the broader national

political-economy.

Coterminous with these developments, of course, has been the meteoric rise of

transborder commercial activities and cross-border functional linkages, creating complex

interdependent relationships between states and between states and markets and thus

exposing various actors to the vagaries of risk transmission across borders. Much of this

has been expressed in terms of the political risk experienced by MNEs through foreign

investment activities but equally through interdependent financial markets and the

transmission of market risk associated with political and economic instability. Indeed, it

has been the enormous and increasing volumes of transborder trade, investment and

production that has increasingly driven the demand for political risk analysis, with

international business otherwise forced to navigate an often turbulent international

environment dominated first by the Cold War and now the war on terror, numerous

intermittent international crises (Korea, Vietnam, Cuba, Iran, Iraq, Suez, Algeria, Sudan

―― to name but a few), international financial crises (Latin American and African debt

crises of the 1980s, the Asian financial crisis, Russian Ruble crisis, Brazilian and

Argentinean financial crises of 2002-2003), as well as an assortment of country crises

ranging from coups, revolutions and civil war ―― among others. The vast bulk of the

13 | P a g e

literature and the majority usage of the term political risk is thus normally invoked in

relation to the activities of foreign governments and their impact on foreign interests

(most often MNEs) or global markets, where political risk analysis is used as a means to

protect and preserve the value of foreign investments, business operations and of plant

and equipment, and or to assess the prospects for discord and threat.

Finally, a praxis based understanding of political risk also helps explain its increasing

application despite the advent of globalization and what should, nominally, be a reduction

in risk associated with transborder activities. Rather, despite the deepening of

globalization in terms of cross-boarder investment and flows of goods and services, the

persistence of a Westphalian state-system and of state sovereignty presupposes exposure

to multifarious political, regulatory, legal and economic environments which has

increased the need for acutely focused political risk analyses not only to protect the

financial interests of overseas investments and operations but also to meet the compliance

and regulatory requirements for legal operation and listing in home country bourses. The

resurgent interest in political risk is thus partly explained by the ever increasing

complexity of commercial operations across numerous jurisdictions, increasing the

regulatory and operational risks associated with normal everyday commercial practices.

It is this final point that generates a strange paradox for political risk analysts: while

political risk is obviously a function of political activity in domestic settings, it is

increasingly experienced as a function of globalization and interdependence, where, on

the one hand, globalization promotes the emergence of functional interdependence,

transnational regimes and the increasing standardization of international norms and rule

governed behavior, but, on the other hand, where the depth of these regimes and

interdependence is not so extensive that it reverses the dominance of sovereignty as a

juridical reality in the administration of the national polis, society and economy. The

intersection of transboader activities (commercial and non-commercial) amid persistent

sovereignty thus represents one of the primary causal agents responsible for generating

political risk. Arguably, it is in this context that most intellectual effort has been devoted

over the last several decades, with attempts to articulate the various ways the

14 | P a g e

interconnection of political risk events effect markets and national based economic

systems and, more particularly, how foreign investors experience political risk, how best

to manage and mitigate it and, more importantly, to develop theoretical models able to

forecast and anticipate it (see Figure 1.3).

15 | P a g e

Figure 1.2

Prxiological Interrelationship of Risk Analysis

International Business Risk

Analysis

International Risk Analysis

Public Sector & Institutional

Risk Analysis

Policy Risk Analysis

16 | P a g e

Figure 1.3 Political Risk: Generative Drivers

Domestic International Environment Environment Institutional Policy Environment Environment

Political Risk Drivers

Interdependence

Globalization

17 | P a g e

The Evolution of Theory and Method in Political Risk Analysis

As noted in the previous section, the etiology and epistemology of political risk make

anything other than a praxis ontology definition problematic. Conceptual approaches and

attempts to theoretically model political risk thus reflect the often discrete disciplinary

perspectives in which they have developed and, indeed, considerable confusion because

of the spread of approaches and their apparently dissonant perspectives based on different

end user applications. As also noted, however, the analytical and conceptual focal plane

of those who attempt to identify, measure and analyze political risk in fact shows

remarkable continuity (Figure 1.2), situated around concerns with political stability,

political system type, policy continuity, institutional stability and probity, and the rule of

law, governance and transparency. Despite this consistency in analytical focus, however,

the conceptual apparatus devised to interpret these parameters vary widely as does the

ascription of their importance as harbingers of risk, risk generators and as transmission

agents of risk. In somewhat circular fashion, the evolution of approaches to political risk

assessment and measurement thus seem to perennially revisit issues of definition, or at

least issues about what precise parameters need to be measured / assessed in order to

understand both the severity of risk and its consequences. It is this debate that has created

wide variation in methodological approach and theoretical apparatus, falling into four

distinctive generations of theoretical and methodological effort.

First Generation Political Risk Approaches: The Catalogue School

By far the dominant praxis application of political risk analysis has been in relation to its

negative consequences for the cross-border investment activities of MNEs; where

political risk is seen to arise from actions taken by host governments, government

agencies, or political actors in host countries which adversely impact the operations,

value or profitability of MNE’s.10 On this understanding political risk has been

approached as the amalgam of “unwanted consequences of political activity,” or, more

10 See David H. Blake (1982), “The Political Environs of Multinational Corporations,” in Ingo Walter and Tracy Murray (eds.), Handbook of International Business. New York: John Wiley & Sons, pp.7.3-7.21.

18 | P a g e

specifically, the series of things that governments, their agencies or domestic political

actors do that interferes with the business of MNE, threatens assets or distorts markets

and the parameters of normal economic competition.11 Zarkada-Fraser and Fraser, for

example, note that “political risk is the aggregate negative effect of governmental and

societal actions and / or inertia on a select group or all foreign concerns operating in or

wishing to penetrate a country’s market.”12 Governments do things that invariably create

obstacles or imperfect competition, delimiting the ability of business to act it ways that it

normally would were it free to do so.

These approaches fall into what we might loosely define as the catalogue school, where

practitioners simply develop lists of the possible negative activities of governments in

host countries that detract, or have the potential to detract, from business operations,

value and profitability. Anaam Hasmi and Turgut Guvenli, for example, after surveying

leading US MNE’s, conclude that political risk is comprised predominantly of 14

governmental activities and political processes in host countries (see Table 1.1).13

Table 1.1: Political Risk: Catalogue School Approach

RANK Political Risk Activity 1 (highest) Import restriction

2 Unexpected currency devaluation or revaluation of non-

floating currencies

3 Delays in profit repatriation

4 Currency inconvertibility

5 Terrorism

11 Stephen Kobrin (1979), “Political Risk: A Review and Reconsideration,” Journal of International Business Studies, Vol. 10, p.67. 12 Anna Zakada-Fraser and Campbell Fraser (2002), “Risk Perception by UK Firms Towards the Russian Market,” International Journal of Project Management, Vol. 20, p.99. 13 M. Anaam Hasmi and Turgut Guvenli, (1992), “Importance of Political Risk Assessment Function in U.S. Multinational Corporations,” Global Finance Journal, 3(2), pp.137-144.

19 | P a g e

6 Unfair tax laws

7 Labor strikes and trade union power

8 Production or export restrictions

10 Contract repudiation

11 Restrictions on local market access

12 Expropriation or nationalization

13 Confiscation of property

14 (Lowest) Restrictions on information flow

Source: M. Anaam Hasmi and Turgut Guvenli, (1992), “Importance of Political Risk

Assessment Function in U.S. Multinational Corporations,” Global Finance Journal, 3(2),

pp.137-144.

This same approach is represented in the work of Fred Weston and Bart Sorge, who note

“political 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 owned business property.”14 In this same genre, David

Conklin notes that political risk encompasses the range of governmental and political

activities antithetical to business interests: government expropriation, regulations and

imposed inefficiencies, foreign investment restrictions, extensive tariff and non-tariff

barriers to foreign trade and investment, as well as bribery and corruption.15 Political risk

is conceived as government / political intrusion into otherwise sanguine, functioning and

efficient markets. Indeed, Conklin makes the explicit linkage between political risk,

market intrusion, government regulation and economic freedom; where markets are seen

as perfect and politics as a corrupting influence on markets. Citing the Index of Economic

14 Fred V. Weston and Bart W. Sorge (1972), International Managerial Finance. Homewood, IL: Richard D. Irwin, p.60. 15 David W. Conklin (2002), “Analyzing and Managing Country Risks,” Ivey Business Journal, 66(3), January–February, p.17.

20 | P a g e

Freedom, Conklin is keen to suggest that less government, less regulation and less

politics equates with lower political risk to business.16

Such approaches and the assumptions they entail tend to be dominant among the initial

wave of political risk literature that emerged in the early 1950s and, indeed, continues to

exert significant influence today. It is, as Stephen Kobrin notes, the first generation of

political risk theorizing and represents a collective effort to disentangle the multifarious

series of non-financial and non-market risks into discrete categories in order that they

might be analyzed systemically, assessed, their consequences better understood and their

effects mitigated.

As Kobrin also notes, however, this first generation approach to political risk is

conceptually flawed and of limited methodological value. It assumes a rather simplistic

view not just of political processes but of markets. First, it entails an a priori assumption

that markets are perfect or near perfect, prone to equilibrium, self-regulating and

otherwise functional. Second, it assumes markets are ontologically prescient to politics;

stand alone entities that are forced to interface with non-market actors and non-market

signals and thus constructing an image of a naturally bifurcated, mutually exclusive and

opposing set of actors, processes, and systems—political systems versus economic

markets. Markets, on this understanding, are self-iterative and constituted by the

amalgam of economic participants responding to transparent market signals and egoistic

self interest defined by profit maximization. The notion of imperfect markets, poor

transparency, and activities like monopoly practices, organizational self-preservation,

collusion, or any other anti-competitive activity, is otherwise delimited from the

theoretical purview of such approaches. Third, such approaches assume that markets are

not embedded in states or a broader societal polity, and thus ascribe normative and

projective values to politics and political processes, viewing them as intrusive to markets 16 ibid., pp.17-18. See the Index of Economic Freedom at The Fraser Institute, Canada (www.fraserinstitute.ca) and at The Heritage Organization (www.heritage.org/index). See also James Gwartney and Robert Lawson (2003), Economic Freedom of the World: 2003 Annual Report. Fraser Institute: Vancouver, Canada. An excellent critique of the Fraser Institute and the Heritage Foundation economic freedom index approach is provided by Lewis W. Snider (2004), “Comparing Measures of Economic Freedom: The Good, the Bad and the Data,” in Jerry Rodgers (ed.), Global Risk Assessments: Issues, Concepts and Applications (Book 5), Riverside California: Global Risk Assessments, pp.181-228.

21 | P a g e

and alien to efficient market operation. This artificially disembeds markets and business

relations from their socio-political contexts and, by implication, sees all political activity

as negative, market distorting, and detrimental to business and profitability. Politics and

political processes are therefore approached as disarticulating events that breakdown

markets, create risks and increase business costs. For these theorists, political risks exist

because of politics and governments, and can thus only be removed by limiting

government, its power and regulatory reach.

First generation theorizing thus reveals an ideological commitment to economic

libertarianism and laissez-faire economics, and a distrust of government and politics. This

approach, however, tends simply to generate lists that highlight activities deemed to be

normatively undesirable. More obviously, the conceptual basis for understanding political

risk is merely based on value-laden assumptions and not analytically rooted in the

correlation between specific political events / processes / actions and their effects on

business.

Perhaps more unfortunately, first generation approaches to political risk tend to render

analytically invisible the role of the state as an enabling agent of commercial practice. As

economic historians have long recognized, nation-states and their regulatory arms are

prescient to market operation and a necessary conduit to insure the transmission of

market information and transparency.17 Rather than the presence of such actors, it is their

absence which increases the extensity of political risk and its veracity. The great lesson of

the 1997 Asian financial crises, for example, has been to affirm the centrality of

functioning political systems and regulatory bodies for sound economic outcomes. Weak

state capacity makes for poor economic outcomes, and weak state institutions create

conditions prone to market failure or distortion. The recent and on-going emphasis on

governance by leading international agencies like the International Monetary Fund (IMF)

and World Bank, for example, stresses the adequacy of institutional capacity to support

the operation of financial markets, market transparency and probity, and provide

administrative and legal corridors for the transfer of assets, debt, and debt settlement.

17 See Karl Polanyi (1975), The Great Transformation. New York: Octagon Books

22 | P a g e

Without state and institutional capacity, markets very often implode or function

inappropriately and expose participants to risk.18

The relatively crude conceptual apparatus offered by first generation political risk

approaches thus leaves little room to develop methodological frameworks that treat

seriously political processes and the manner in which they manifest and articulate with

markets. Political risk is treated exogenously, as a set of market interventions with

negative consequences. The fact that political risk can stem from the absence of effective,

functioning political systems and political institutions, is an obvious hole in the

intellectual amour of first generation approaches, and leaves this literature bereft of

methodological tools able to forecast political risk, analyze its likely future dimensions,

or to manage and mitigate its consequences.

Second Generation Political Risk Approaches: The System–Event School

Second generation political risk approaches implicitly recognize the limitations of the

catalogue school characteristic of the first generation of political risk literature.

Delimiting political risk to the activities of governments, disallows consideration of state

and system type, and of possible correlations between a political system and political risk.

Moreover, intuitive and empirical observation suggests broad correlates exist between

certain types of states and the level and extensity of certain political risks. Particular state

types, for example, display less stability, are more prone to nefarious political activity,

crime, corruption and regime change than are other state types. Different states thus have

different political risk profiles, opening up the possibility of developing models that can

correlate system characteristics with the likely development of specific political risk

events. For political risk theorists, this represents the holy-grail of theorizing and holds

18 See, for example, World Bank (2000), Reforming Public Institutions and Strengthening Governance: A World Bank Strategy. November, Washington, D.C.,: World Bank. See also the current discussion surrounding prudential and state regulation in respect of liberalization in emerging economies in financial services, education, and the telecommunications industries in ASEAN. Darryl S.L. Jarvis, Anthony Welch & Ben Tipton (2002), Building Institutional Capacity in Asia: Public Sector Reform in Financial Services, Telecommunications, ICT, and Education in Five ASEAN States. Ministry of Finance, Japan and the Research Institute for Asia and the Pacific, University of Sydney, Australia.

23 | P a g e

out the prospect of developing prescriptive social science models able to alert investors,

states and or stakeholders to future risk events and thereby avoid exposure to them.

Unlike first generation political risk approaches, second generation approaches

understand the mutually constitutive nature of political systems and markets, seeing

economic growth and political modernization as functionally interdependent; the absence

of one invariably impacting the other and leading to either mal-development, uneven

development, or various forms of political incapacity where economic growth and

modernization are not supported by the maturation of political institutions, regime

legitimacy, increasing democratic participation or the deepening of state institutional

capacity. Economic growth is thus no indicator of political risk, indeed economic

modernization can in fact generate political risk in situations where the absence of

political development, or the inability of the political system or political elites to

accommodate the demands of emerging powerful constituencies, precipitates political

crisis and radical political change. Second generation political risk approaches thus

embrace an interstitial understanding of economics and politics, or states and markets,

and treat both as mutually constitutive and co-reflexive.

Second generation approaches to political risk are informed directly by political

modernization theory and the spate of studies surrounding the decolonization process and

the emergence of numerous new, fragile states in the immediate aftermath of the Second

World War. While development economists attempted to distil the conditions necessary

for economic growth, industrialization, and mass consumptive society, political scientists

and sociologists were equally at work discerning the conditions necessary for political

modernization, institutional development, and the emergence of mature, liberal

democratic societies.19 What was it that caused societies to develop politically, for

19 The most famous scholar of economic modernization was Walt W. Rostow and his five stages of economic growth. See Walt W. Rostow (1960), The Stages of Economic Growth: A Non Communist Manifesto. Cambridge: Cambridge University Press. In political science, political modernization theory was championed by scholars like Samuel P. Huntington (1968), Political Order in Changing Societies. New Haven: Yale University Press; Gabriel A. Almond and G. Bingham Powell (1966), Comparative Politics: A Developmental Approach. Boston: Little Brown; Gabriel A. Almond, et. al. (1973), Crisis, Choice, and Change: Historical Studies of Political Development. Boston: Little Brown; Gabriel A. Almond and James S. Coleman (1960), The Politics of Developing Areas. Princeton, N.J.: Princeton University Press.

24 | P a g e

political cultures and political institutions to emerge and support complex economic

systems and production networks?

The answers come predominantly from the identification of pattern variables endemic to

cultural, social, and political modernization.20 Developed societies display certain social

and political attributes; functional differentiation, specialization, individual autonomy,

adaptation, and increasing complexity. They also display increasing socio-political

differentiation facilitating wider freedoms from the binds of family, locality, and religion

(individualism; separation of state and church; secularism, social atomization), but set

amid integrative dynamics and technologies that otherwise reproduce social orders and

create larger societal wide referents beyond familial / clan association (citizenship,

nationalism). These evolutionary universals are associated with structural-functional

attributes that, if identified, can be transplanted or diffused into emerging societies,

helping quicken the pace of development and avert the social and political ills of political

backwardness.21

Structural-functional analysis garnered a whole series of studies into the comparative

strengths and weaknesses of specific state types, and the political, cultural, regulatory and

social environment endemic to their composition; in the process producing

comprehensive typologies.22 For political risk theorists it was thus only a short analytical

jump to attempt to infer the probability of event scenarios like regime change, revolution,

civil disturbance, or the extensity of probity associated with specific types of emerging

political systems. While not a predictive tool that could be correlated to specific future

risk events, structural functional analysis could provide insights into the risks associated

20 See Talcott Parsons (1960) Structure and Process in Modern Society. Glencoe, Illinois: Free Press; Talcott Parsons (1956), Economy and Society: A Study in the Integration of Economic and Social Theory. London: Routledge and Kegan Paul. 21 See, for example, Henry Bernstein (1979), Sociology of Underdevelopment Versus the Sociology of Development,” in David Lehmann (ed.), Development Theory: Four Critical Essays. London: Frank Cass, pp.77-106; Shmuel Noah Eisendstadt (1968), The Protestant Ethic and Modernization; A Comparative View. New York: Basic Books; Shmuel Noah Eisendstadt (1966), Modernization, Protest and Change. Englewood Cliffs, N.J.: Prentice Hall. 22 The quintessential study in this approach is Gabriel A. Almond and James S. Coleman (1960), The Politics of Developing Areas. Princeton, N.J.: Princeton University Press.

25 | P a g e

with specific stages in the political modernization cycle, and of possible trigger points

that could preempt political instability or derail further modernization.

These second generation approaches to political risk generally coalesce around what we

might loosely term the system-event school. This school stresses the identification of

events which impact regime stability and detract from the incumbent regime’s capacity to

govern, or system characteristics which facilitate the emergence of political events and

which detract from system stability, political maturation and legitimacy. Dan Haendel,

Gerald West and Robert Meadow, for example, develop a fifteen category model

composed of lists of constituent elements which impact on “political system stability.”

This is then used to generate a “political system stability index” comprised of weighted

indicators for socioeconomic, governmental processes and societal conflict risk

indicators.23 Likewise, an events approach to political risk is also demonstrated in the

work of Bunn and Mustafaoglu, who identify ten event categories each with sub-

constituent elements that are assumed to have operational implications for foreign firms

and which originate from the imperfect governance structures associated with emerging

or modernizing societies.24

A similar events approach is also advanced by Pahud de Mortanges and Allers who

suggest that political risk is composed of event elements such as social or political unrest,

expropriation, labor problems associated with strikes, problems associated with profit

remittance such as currency controls, or events associated with the imposition of import

restrictions or contract and legal problems.25 These events derive from a specific system

type, normally modernizing fragile states prone to be captured by domestic constituencies

and otherwise not able to exert control and implement policy in the longer term interests

of the nation as a whole. Captured states, in other words, pursue policies that reflect the

narrow sectional interests of ruling elites within emerging states, increasing the political

23 Dan Haendel, Gerald T. West and Robert G. Meadows (1975), Overseas Investment and Political Risk. Philadelphia: Foreign Policy Research Institute. 24 Bunn, D.W., & Mustafaoglu, M.M., (1978), “Forecasting Political Risk,” Management Science, 24(15), November, pp. 1557-1567. 25 Pahud de Mortanges, C., and Allers, V., (1996), “Political Risk Assessment; Theory and the Experience of Dutch Firms,” International Business Review, 5(3), pp.305-304.

26 | P a g e

risks for foreign investors and jeopardizing the longer term economic benefits to the

nation.26

Political Risk and System Type

For second generation approaches political risk is understood as reflecting a continuum

that ranges from high to low and corresponds roughly to political systems that are

undeveloped compared to those that are highly developed. Robert Green, for example,

defines political risk as a function of political stability or the propensity for “radical

political change” due to immature or compromised and maladapted political systems.27

Political risk is simply a reflection of the capacity of a state and its political system to

manage political events, competing sectional interests, exercise legitimacy, and discharge

the functions of statehood in a non-violent, stable, orderly, democratic manner. From this,

Green is able to develop a typology of political systems and generate a rank ordering

approach correlating system type to political risk and political instability (see Table 1.2).

Table 1.2: Political System: Political Risk & Political Instability

Modernized Nation-States System

Type

Features Examples Political

Risk

Political

Instability

Instrumental

Adaptive

High level of political transparency;

political system displays high levels

United States;

United

Low Low

26 Several other similar approaches are also of note. Paulgeorg Juhl compares a series of environmental factors as well as data on political stability to generate correlates between system type and stability. Similarly, R. Rummel and David Heenan integrate qualitative assessment methods drawn from the Delphi technique with quantitative methods, in particular using multivariate analysis to predict instability in Indonesia. See Paulgeorg Juhl (1976), “Prospects for Foreign Direct Investment in Developing Countries,” in Herbert Giersch (ed.), Reshaping the World Economic Order. Kiel: Tubingen, pp.XXXX; Rummell, R.J. and David A. Heenan (1978), “How Multinationals Analyze Political Risk.” Harvard Business Review, January-February, pp.67-76. 27 See Robert T. Green (1972), Political Instability as a Determinant of U.S. Foreign Investment. Austin, Bureau of Business Research, Graduate School of Business, University of Austin, Texas. See also the discussion in Dan Haendel (1979), Foreign Investment and the Management of Political Risk. Boulder, Colorado: Westview Press, p.79.

27 | P a g e

Systems of legitimacy; embedded political

institutions, representative

participatory democracy; diffuse

decision making institutions; high

level of state capacity; highly

evolved state based institutions; high

level of public probity; regulatory

reach of the state entrenched

Kingdom;

Australia;

Canada; New

Zealand

Instrumental

Non-

Adaptive

Systems

Relative high level of political

transparency; political systems

displays recurrent crisis of

legitimacy; varying levels of

democratic participation; moderate

to high state capacity; regulatory

reach of state sometimes

compromised

France; Spain;

Italy

Low to

Medium

Low to

Medium

Modernizing Nation-States System

Type

Features Examples Political

Risk

Political

Instability

Instrumental

and quasi-

instrumental

systems

attempting

adaptive

Emergent forms of democratic

representation; uneven levels of

democratic participation; circulation

of, and intense competition between,

political elites; moderate state

capacity; regulatory reach of state

India; Turkey;

Mexico;

Brazil; Czech

Republic;

Slovakia;

Russia;

Moderate Moderate

28 | P a g e

politics varies across sectors; varying levels

of political transparency; immature

political legitimacy; political

institutions not deeply embedded;

un-coordinated decision making

institutions

Hungary;

Bulgaria;

South Korea;

Modernizing

Autocracies

Centralized power structures;

modernizing elites; low level of

political participation; poor level of

political transparency; moderate

levels of political legitimacy tied to

growth in economic well being;

moderate levels of public probity;

intolerance of political dissent

Syria; Jorden Low to

moderate

Low

Military

Dictatorships

Autocratic centralization of power;

military power used to secure

political legitimacy; lawfulness

secured though force; low political

participation; centralized

hierarchical decision making

structures; political dissent violently

quashed

Burma; Central

African

Republic;

Guinea-Bissau;

Libya

Moderate

to High

Moderate

to High

Mobilization

Systems

Centralized command systems; low

levels of political participation; low

levels of political transparency; high

degree of centralized decision

making; high level of bureaucratic

administration; low level of state

responsiveness; political dissent

quashed

China;

Vietnam;

Cuba; North

Korea; Laos

Moderate

to High

Low to

Moderate

Emergent Newly acquired independence, or East Timor; High Moderate

29 | P a g e

Systems;

Transition

States

political systems transiting from

autocratic rule; immature political

systems, low to poor levels of

political legitimacy; poorly

embedded political institutions; low

levels of political transparency;

interrupted period of civil order and

lawfulness; low public probity;

undeveloped political culture;

varying forms of political

participation; intense and

exclusionist politics between

political elites; widespread political

contestation; frequent political

dissent

Romania;

Indonesia;

to High

Source: Adapted from Robert T. Green (1972), Political Instability as a Determinant of

U.S. Foreign Investment. Austin, Bureau of Business Research, Graduate School of

Business, University of Austin, Texas; David E. Apter (1965) The Politics of

Modernization. Chicago: University of Chicago Press; Gabriel A. Almond (1966),

Comparative Politics: A Developmental Approach. Boston: Little Brown

Political risk and the possibility of political instability for Green correlates inversely with

the level of modernization and adaptability of a political system; the more developed and

institutionally sophisticated the political system, the lower the risk and the lower the

prospect of political instability in terms of sudden structural change. Political risk

increases, by and large, the more primitive the political system, the less adaptive the state,

or the more prone the state is to being captured by sectional interests. More importantly,

the level of political risk is assumed to be positively correlated to stress caused by rapid

economic modernization, where the political system can be overstretched to the point of

30 | P a g e

crisis when confronted with complex demands occasioned by rapid development, social

dislocation, and the emergence of issues for which it does not have the institutional

capacity to tackle: rising expectations, distributional justice, new emergent powerful

constituencies.28

For Green, these insights suggest various investment strategies for avoiding political risk.

First, identify the system-type into which the country falls, then design investment

strategies which reflect the political risk profile of the country. Thus, in the case of

military dictatorships where legitimacy is low, the use of violence ubiquitous, and sudden

regime change or popular up-rising possible, avoid long term investments, use short term

investment vehicles, minimize sunk costs, attempt to contain investments in liquid and

easily withdrawn assets. Conversely, emerging societies that fell into what Green calls

instrumental and quasi-instrumental systems promise the least political risk, inviting

longer term investment and able to support higher sunk costs with exposure to fixed

infrastructure (mining, production) with relatively low political risk. Not unexpectedly,

instrumental adaptive systems display the lowest levels of political risk and the highest

levels of political stability, able to absorb long term investments, high sunk costs, and

multiple investment exposures with relatively low political risk.

The System-Events School: Successes and Failures?

While second generation approaches to political risk personified in the system-events

school mark the high point of theorizing and the possibility of grand theory with

prescriptive outcomes, in reality its achievements have been less than promised and its

analytical utility circumscribed by self-referential assumptions. Part of the problem stems

from its circular logic; that low political risk and high political stability are personified in

systems that are developed, predominantly western, liberal democratic, and capitalist. By

definition any state that displays dissimilar characteristics harbor political risk and the

possibility of instability. On this understanding, political risk is little more than the

28 See Robert T. Green (1974), “Political Structures as a Predictor of Radical Political Change,” Columbia Journal of World Business, Spring, pp. 31-35.

31 | P a g e

attributes of non-western states, betraying what many critics level as ethnocentric values

and neo-imperialist attitudes in the diagnosis and political prescriptions for developing

countries.29 This belies an understanding of political risk that is relatively unsophisticated

and bound to cultural perceptions rather than analytically cemented in approaches able to

connect system structure and political activities to risk events.

Second generation approaches also display a capricious understanding of political

stability and political risk. Why is political instability or regime change necessarily bad or

a risk to business? Political stability interrupted by sudden system change to replace

despotic dictatorships, for example, generally signifies a lessening of political risk,

greater political transparency, and seeds the ground for less autocratic intervention into

the economy. Moreover, sudden, dramatic political events like regime change, apart from

being infrequent, are not themselves always hazardous to business activity or the

operations of MNEs. Regime change in Indonesia with the fall of President Suharto, for

example, had no immediate consequences for the presence of foreign business interests,

indeed many welcomed regime change and the greater economic freedom without corrupt

intervention that the fall of Suharto signaled.

Thus, the equation of political instability with political risk, while intuitively appealing,

in reality bears little direct correlation. While regime instability or sudden regime change

can certainly “spook” investors, there are few empirical grounds to infer a strong

correlation between regime change, political risk and any impact upon the activities of

foreign investors. Indeed, large risk events such as nationalization or expropriation,

normally occur under conditions of relative regime and political stability, and reflect state

capacity, institutional depth and authority to undertake such activities. Put simply, second

generation approaches to political risk only look at political events and system structure,

but can not infer causality models or establish direct correlations between these events

and their impact upon firms. As Stephen Kobrin notes:

29 See the writings of Paul A. Baran and Paul M. Sweezy (1966), Monopoly Capital: An Essay on the American Social and Economic Order. New York: Monthly Review Press; Andre Gunder Frank (1970), Latin America: Underdevelopment or Revolution, Essays on the Development of Underdevelopment and the Immediate Enemy. New York: Monthly Review Press.

32 | P a g e

What we are, or should be, concerned with is the impact of events which are

political in the sense that they arise from power or authority relationships and

which effect (or have the potential to affect) the firm’s operations. Not the events,

qua events, but their potential manifestation as constraints upon firm investments

should be of concern.30

In part, this anomaly is explained by the system-events school’s treatment of foreign

investment as a ubiquitous category without allowing for wide variation in investment

type. Different investment types interact with regulatory regimes, political systems,

political coalitions and political elites differently, and thus experience different forms of

political risk. Attempting to generate grand system wide correlations and universal theory,

ignores the fact that not all political events have the same risk implications for all foreign

investment. In Nigeria, for example, The Royal Dutch Shell company has successfully

operated physical plant, equipment, and pipelines despite widespread civil unrest and

continuing political instability; an environment that would be unthinkable for retail

chains or manufacturers. The ability to analytically disentangle investment types and

then demonstrate causality between political events, political systems and their impact

upon various investments, thus escapes entirely the system-events approach. As Kobrin

again notes, despite the fact that most political risk approaches have been developed with

the aim of helping international business assess the political environment, nearly all

“measure political stability rather than the potential impact of politics upon the firm.”31

A related problem rests on the cross-comparative applicability of system stability theory.

Can the attributes that contribute to political instability in one country be generalized

across others? As Claude Ake notes, the development of such theory might be elusive,

since factors that produce instability in one state might not be relevant to other political

30 Stephen Kobrin (1979), “Political Risk: A Review and Reconsideration,” Journal of International Business Studies, Vol. 10, p.71. See also the discussion in Robert A. Poirier (1997), “Political Risk Analysis and Tourism,” Annals of Tourism Research, 24(3), p.677. 31 ibid., p.76.

33 | P a g e

systems or produce the same type of instability—if at all.32 More fundamentally, what is

meant by political instability? If it refers to regime change can it be assumed

automatically that this equates with policy change? If it cannot, then why focus on regime

change when policy changes are likely to have the greater impact on economic actors?33

Conversely, should it be assumed that political stability infers policy stability or

continuity? Radical policy change often occurs in situations of political stability and

reflects regime legitimacy and strong state and institutional capacity to withstand

domestic protest and lobby groups. In all, then, political instability as the variable the

system-events school tries to measure, might not be the variable that needs measuring.34

Finally, and with obvious hindsight, the system-events school has had few predictive

successes, with such approaches unable to develop forecasts about system type and

political events with any precision. In a sense, then, what is the analytical utility of an

approach that can not meet basic performance criteria, or develop models able to inform

probable future outcomes? While this is a problem endemic to social science forecasting

generally, it nonetheless highlights the analytical limitations of second generation

approaches. One of the greatest political events of the twentieth century, for example, the

fall of the Soviet Union, went without any prescience on the part of political scientists or

international relations scholars—indeed caught many by complete surprise. Likewise, the

fall of Suharto, the people revolution in the Philippines that disposed President Marcos,

the fall of the Shah in Iran in 1979, the rollercoaster of political disruption in the wake of

the Asian financial crises, or any number of similar sudden political events, have all

escaped forecasting despite several decades of political science models and theorizing.

The great hope of second generation approaches, especially in terms of better modeling,

precession, and the ability to generate prescriptive outcomes, has thus not eventuated.

32 See Claude Ake (1974), “Modernization and Political Instability: An Explanation,” World Politics, Vol.26, pp.576-591. 33 See the discussion in Howard L. Lax (1983), Political Risk in the International Oil and Gas Industry. Boston: International Human Resources Development Corporation, pp.101-105. 34 See the discussion in Kent D. Miller (1992), “A Framework for Integrated Risk Management in International Business,” Journal of International Business, 23(2), p.314.

34 | P a g e

Robock and the Process School: Operationalizing Political Risk Identification and

Assessment

While the systems-event school’s approach to political risk proved mostly unfruitful in its

outcomes, other second generation approaches focused more formally on methods and

definitional precision in an attempt to develop conceptual frameworks for identifying and

assessing political risk. One of the most informative and widely quoted of these

approaches is provided by Stefan H. Robock. Unlike Green and the system-events school,

Robock seeks to operationalize political risk approaches into a fully functional method;

one that is dynamic and able to feed into corporate decision making. To do so, Robock is

interested in political processes as they occur in political systems rather than the structure

of political systems themselves. This distinction is important, differentiating between

analyses that are concerned with the identification of political system risks from

approaches that stress the identification of political risks that impact foreign investment.

As Robock notes, while:

…political scientists have done considerable research on the subject of ‘political

instability’ in the form of revolutions…the political scientists’ principal focus of

interest is not likely to produce the answers needed for international business. For

one thing, the discontinuities that might affect international business do not

necessarily require a revolution. Another consideration is that ‘political

instability,’ as represented, for example, by an unexpected change in government

leadership, may or may not involve political risk for international business.35

Robock’s point is well taken and distinguishes between political instability and political

risk. Political risk is particularistic and contextual; political instability is systemic and not

necessarily a risk to foreign investment. Robock’s focus is thus more refined than the

system-events school and delimits political risk to contextual processes with direct

implications for foreign investors:

35 Stefan H. Robock (1971), Political Risk Identification and Assessment,” Columbia Journal of World Business, 6(4), p.8.

35 | P a g e

Political risk in international business exists (1) when discontinuities occur in the

business environment, (2) when they are difficult to anticipate and (3) when they

result from political change. To constitute ‘risk’ these changes in the business

environment must have a potential for significantly affecting the profit or other

goals of a particular enterprise.36

Robock is thus able to stipulate that “political fluctuations which do not change the

business environment significantly do not present political risk.” Importantly, then,

political processes and political change are viewed as evolutionary rather than

cataclysmic, sporadic, or necessarily antithetical to foreign investment, and part of the

normal regulatory and political tapestry that comprises states and markets:

…political consideration are continually modifying the business

environment…but not all such changes can properly be considered as political

risk. Where change is gradual, progressive and reflects continuity in government

policies and political forces, future events are neither unexpected nor difficult to

anticipate.37

Building on this framework thus requires contextual analyses of political processes,

recognizing that specificity in political risk analysis is central to realizing accurate and

useful outcomes. Why the emphasis on specificity? Robock is clear: “what is political

risk for one firm may not be political risk for another.”38 Political risk thus falls in to two

categories for Robock; political processes or changes to the business environment which

are ubiquitous, or what Robock calls macro political risk which impact broadly all

foreign enterprises in a nation-state, and micro political risks which are “selectively

directed toward specific fields of business activity.”39 The former, he notes, are generally

infrequent but very dramatic; the latter less dramatic but more prevalent and recurrent.

36 ibid., p.7. 37 ibid., pp.7-8. 38 ibid., pp.7-8 39 ibid., p.10.

36 | P a g e

This is an elemental point for Robock and differentiates his approach and emphasis on

the identification and assessment of micro political risks from the system-events school’s

emphasis on macro political risks. Robock’s approach is conceptualized in Table 1.3.

Table 1.3: Political Risk: Robock’s Conceptual Framework for Identification and Assessment

Sources of Political Risk Groups through which

political risk can be

generated

Political Risk Effects:

Types of influence on

international business

operations

Competing National

Philosophies (Nationalism,

Capitalism, Socialism)

Government in power and

its operating agencies

Confiscation: loss of assets

without compensation; loss

of revenue streams

Social unrest and disorder Parliamentary opposition

groups

Expropriation with

compensation: loss of

freedom to operate; loss of

future profit streams;

implications for share

holder value

38 | P a g e

Vested interests of local

business groups; lobby and

interest groups; political

activists (environmentalists;

industry protectionists;

national protectionists)

Non-Parliamentary

opposition groups

(guerrilla/ terrorism groups

operating within or outside

of the country)

Operation restrictions:

market shares, product

characteristics, employment

policies, locally shared

ownership (joint ventures);

foreign ownership

restrictions or ceilings, etc

Recent and impending

political independence /

country transiting to

democracy; political

structures evolving or

subject to change

Non-organized common

interest groups; students,

workers, peasants,

minorities, etc

Loss of transfer freedom:

Financial (e.g. dividends,

interest payments), goods,

personal or ownership

rights

New international alliances;

international organization

membership obligations;

trade bloc membership /

Foreign government or

intergovernmental agencies

such as WTO, IMF, EU, or

regional forum such as

Breaches or unilateral

revisions in contracts and

agreements

39 | P a g e

exclusion ASEAN, LAFTA, NAFTA,

APEC; OAS

Foreign governments

willing to enter into armed

conflict or to support

internal rebellion

Discrimination such as

taxes, compulsory sub-

contracting; stipulated

providers of materials,

services or factor inputs

Damage to property or to

human life / personnel from

riots, insurrection,

revolution, terrorist attacks,

general civil unrest

Source: Adapted from Stefan H. Robock (1971), “Political Risk: Identification and Assessment,” Columbia Journal of World

Business, 6(4), pp.6-20.

Robock and the Process School: Political Science versus International Business

Robock’s approach certainly differentiates between studies of political system structure

and studies about political processes and their impact on firms. In doing so, however, it

attempts to capture political risk as an analytical category and set of processes exclusive

to foreign investors, effectively jettisoning political risk as an experiential category

relevant to other stakeholders (nation-states, governments, non-governmental

organizations, intergovernmental organizations, and other actors within the state system).

This is peculiar since these other actors are invoked by Robock as “groups through which

political risk can be generated” but apparently not actors to which the concept of political

risk is germane! While Robock’s attempt is doubtlessly intended to increase the

analytical precision and utility of political risk to international business, it nevertheless

sets in place a level of analytical exclusivity that, ironically, cuts the concept off from its

ontological and epistemological origins—politics. More generally, political science and

the importance of system-structure is discounted, reduced to the concept of “revolution”

or some equally infrequent event. This, though, discounts the existence of important

correlations between certain political systems and the frequency of various political risks

including those which pose, or have the potential to pose, risk to foreign investment. As

Robert Gilpin notes, if “politics largely determines the framework of economic activity,”

why delimit politics to infrequent, dramatic events such as revolution?

Perhaps the greatest problem of Robock’s process approach, however, concerns the level

of generality endemic to assessing political processes. Robock’s understanding of

political risk does not allow for the development of an unambiguous classification of

environmental events and processes, and a schema for differentiating which events and

processes are of concern from which are not. Absent such a framework, much of what

Robock has to say reverts to developing catalogues of possible risks, the agents through

which they might be transmitted, and how they might articulate. Robock is thus not able

to develop a preemptory schema for assessing the likelihood of specific risks, their

probable character, consequences or severity.

41 | P a g e

Finally, the false dichotomy Robock constructs between the intellectual interests and

concerns of international business practitioners and those of political scientists, seems

disingenuous and ultimately destructive to the emergence of integrated theory able to

analyze risk not just in terms of how it impacts end users (firms), but the drivers and

causal variables from which it originates and its possible future trajectories for a whole

rostrum of end users and stakeholders. To fully appreciate the articulation of political risk

requires a robust analytical framework cognizant of risk drivers, mechanisms of causality,

and the inter-connection between political processes, structures, and the way various

actors (including MNEs) interface with these. Robock’s process oriented approach,

unfortunately, falls short on all these counts.

Third Generation Political Risk Approaches: Method versus Theory

Positivist political science enjoyed wide application in the 1950s through 1970s,

underscored by a desire to replicate the prescriptive and predictive success of the hard

sciences and a belief in the infallibility of rationalist-empirical epistemologies. Political

risk theory was no different, actively pursuing approaches aimed at greater interpretive

proficiency and an ability to achieve the type of analytical insight and correlations typical

of economics. Much of this desire stemmed from the nature of political events occurring

in developing regions, and the political risks typically encountered by foreign investors.

Expropriation and nationalization of foreign interests dominated political risk for the

greater part of the post-war period. In 1975 alone, for example, there were 83 recorded

cases of expropriation. Developing models or frameworks of analysis that might presage

such events thus promised great rewards and were enthusiastically pursued—and not just

in academic circles. As José de la Torre and David Necker note, the environmental

turbulence of the 1950s through 1970s also “gave extraordinary impetus to the

development of in-house capabilities in political and economic assessment among the

world’s largest international corporations.”40

40 José de la Torre and David H. Necker (1988), Forecasting Political Risks for International Operations,” International Journal of Forecasting, Vol. 4, p.229.

42 | P a g e

By the 1980s, however, a relative sea change in host government attitudes toward

external investment witnessed a marked shift in the types of political risks foreign

interests faced. From 1981 to 1992, for example, there were only 11 recorded

expropriations.41 Increasingly, nation-states now compete for FDI and attempt to set in

place policies that attract prospective investors. Large risk events like expropriations,

ideologically motivated coups, mercantilist trade policies, or tariff based protectionist

policies (import substitution industrialization), have become less a feature of the

international political economy. The object of analysis for political risk theorists has thus

changed, as have their analytical approaches and ambitions.

These developments combined with the spate of poor analytical outcomes associated with

second generation approaches to political risk, have witnessed not just a reorientation in

political risk theorizing, but changed substantially the expected outcomes from such

endeavors. Political risk approaches are now more circumspect in their ambitions, aim

less toward grand theoretical correlations and more toward informed micro-analyses that

emphasize contextualism, specificity and project level analysis. Much of this reappraisal,

of course, evolved from the meta-theoretical debates in the social sciences and

humanities that occurred from the 1970s onwards, and which questioned the

epistemological hegemony of positivism while acknowledging the limitations of social

science method.

These approaches fall into a number of discrete categories and offer very different

insights, but all share a general rejection of the grand theoretic tradition of political

science and of the possibility of developing objective, prescriptive, and preemptory

theory with any decree of precision. So too, the attempts to model and develop purely

quantitative tools for political risk analysis are generally rejected on the basis that the 41 Theodore H. Moran (1998), “The Changing Nature of Political Risk,” in Theodore H. Moran (ed.), Managing International Political Risk. Oxford: Blackwell, p.8. See also J.M. Chermak (1992), “Political Risk Analysis,” Resources Policy, 8(3), pp.167-178. The absolute reduction in political risk through expropriation is also evident in survey work conducted in 1992, where are out 14 political risks identified, respondents identified expropriation or property confiscation as 12th. See M. Anaam Hashmi and Turgut Guvenli (1992), “Importance of Political Risk Assessment Function in U.S. Multinational Corporations,” Global Finance Journal, 3(2), pp.141.

43 | P a g e

social and political worlds present too many variables and require such wide

interpretation, that generating data sets of sufficient magnitude is near impossible.

Third generation approaches to political risk, then, in many senses abandon theory for

method, and rather than attempt to develop explanatory schema with predictive capacity,

move toward the development of methods aimed at giving informative appraisals of the

risk environment in relation to industry or project specific applications. This has thrown

up a plethora of approaches, all with varying degrees of utility and none enjoying wide

acceptance as the preeminent approach to political risk assessment. To add to the

confusion, numerous consulting firms have also developed various “systems” or risk

assessment techniques that infuse the literature, creating a profusion of models all

claiming to offer superior insights and greater maneuverability with regard to risk

avoidance. These varying approaches fall into three broad classifications: qualitative

approaches, Semi-quantitative and rank ordering approaches, and scenario based

approaches.

Qualitative Approaches to Political Risk: The Delphi Method

Quantitative methods to theory and knowledge generation enjoy wide application in

scientific inquiry and their success is well demonstrated. In the social sciences, however,

quantitative approaches have yielded mixed results. Data sets tend to be historically

informed, based on circumstances that are often no longer salient. Further, not only are

the depth of data sets constrained relative to the number of actors and possible outcomes,

but the environmental factors that condition social action are not constant but themselves

variable, creating exponential variations on possible outcomes and delimiting the utility

of formal theory approaches to political risk analysis.

Recognizing these problems, Norman Dalkey and Olaf Helmer of the Rand Corporation

developed an approach that circumvented formal modeling for what they termed the

Delphi technique. This relied on the pooling of expertise to generate forecasts and

scenarios in relation to country risks and specific political risks relative to certain

44 | P a g e

problems. In essence, the Delphi technique relies on a controlled feedback questionnaire

administered to a group of experts who are selected independently and whose identities

are not known to each other. The experts are then surveyed and asked to make

assessments and predictions about specific developments. Their responses are then

tabulated and a series of scenarios generated.42

The Delphi method is a useful and widely utilized tool for identifying and forecasting

political risk. It draws on experts with first hand knowledge of political events and

processes in specific settings, and avoids the pitfalls of group-think and brainstorming

approaches that often work on consensus models which can change the assessments of

individual participants due to group dynamics. However, it also suffers from some

serious drawbacks. First, the results it produces are contingent on the quality of expert

participants identified; are these readily available, will they devote sufficient time to

responding to the survey; are the experts biased, are the expert survey participants

representative of a broad cross section of specialists? The Delphi technique provides no

scope for indemnifying against these problems and the skewed results they could produce.

Second, the design of the questionnaire can have a large impact on the results generated

and condition feedback or bias respondents. Ultimately, then, the Delphi technique relies

on the quality and expertise of the analyst responsible for designing the questionnaire, the

weighting they give to specific areas and questions, and the agenda they set in terms of

the focus of the questionnaire. Third, the responses generated by the expert participants

still require interpretation and synthesis, suggesting that expert responses can be

unconsciously manipulated by the survey administrator(s). Fourth, reports generated by

the Delphi technique require the assumptions on which the expert participants have

rendered judgments to be clear and transparent, yet there is no basis on which to do this.43

42 Rummel and Heenan also use notions of the “old hands” and “grand tours” approaches as adjunct categories that inform expert opinion about political risk, location, and operational dynamics that might pose risk to foreign investment as a result of political and social practices. See R.J. Rummel and David A. Heenan (1978), “How Multinationals Analyze Political Risk,” Harvard Business Review, January–February, Vol. 56, pp.69-70. See also Geoff Coyle (2003), “Scenario Thinking and Strategic Modelling,” in David O. Faulkner and Andrew Campbell (eds.), The Oxford Handbook of Strategy: A Strategy Overview and Competitive Strategy (Volume 1), Oxford: Oxford University Press, pp.305-306. 43 Martin Shubik (1986), “Political Risk: Analysis, Process, and Purpose,” in Richard J. Herring (ed.), Managing International Risk. Cambridge: Cambridge University Press, pp.127-129.

45 | P a g e

Semi-Quantitative and Risk Ranking Approaches

Numerous attempts have been mounted to measure political risk. These involve the

construction of models that assign relative weightings to select categories deemed to pose

risk to prospective or current investors / actors in either specific countries or particular

industry segments. One of the longest established and better utilized of these approaches

is the International Country Risk Guide (ICRG) produced by Political Risk Services

(PRS). ICRG attempts to integrate a broad cross section of risks from the political,

financial and economic risk environments and develop forecasts based on expected

developments. Aggregating the data and weightings together, PRS produces “total

political risk indicators” and highlight trends and scenarios for utilization by business.

The aim of the “political risk rating is to provide a means of assessing the political

stability” of countries surveyed, by assigning “risk points” to what Llewellyn Howell

terms “risk components.” Risk points are assigned by PRS analysts on the basis of “pre-

set questions” applied to survey countries. The specific questions applied to survey

countries, however, depends on the type of political system displayed. The PRS group

has identified five political system types: Accountable (Alternating) Democracy,

Dominated Democracy, De facto One-Party State, Du jure One-Party State, and Autarchy

(see Table 1.4)

Table 1.4: PRS Political System Types

1. Accountable (Alternating) Democracy: Essential features

• A Government / Executive that has not served more than two successive terms

• Free and fair elections for the legislature and executive as determined by the

constitution or statute

• The active presence of more than one political party and a viable opposition

• Evidence of checks and balances among the three elements of government:

executive, legislative, and judicial

46 | P a g e

• Evidence of an independent judiciary

• Evidence of the protection of personal liberties through constitutional or other

legal guarantees

2. Dominated Democracy: Essential features

• A government / executive that has served more than two successive terms

• Free and fair elections for the legislature and executive as determined by the

constitution or statute

• The active presence of more than one political party

• Evidence of checks and balances between the three elements of government:

executive, legislative, and judicial

• Evidence of an independent judiciary

• Evidence of protection of personal liberties

3. De facto One-Party State: Essential features

• A government / executive that has served more than two successive terms, or

where the political / electoral system is designed or distorted to ensure the

domination of governance by a particular government / executive

• Holding of regular elections as determined by constitution or statute

• Evidence of the restrictions on the activity of non-government political parties

(such as disproportionate media access between the governing and non-

governing parties, harassment of the leaders and / or supporters of non-

government political parties, the creation of impediments and obstacles affecting

only non-government political parties, electoral fraud, etc.

4. De jure One Party State: Essential Features

• A constitutional requirement that there be only one governing party

• Lack of any legally recognized political opposition

5. Autarchy: Essential features

47 | P a g e

• Leadership of the state by a group or single person without being subject to any

franchise, either through military might or inherited right

Source: Adopted from Llewellyn D. Howell (2001), International Country Risk Guide

(ICRG), The PRS Group,” in Llewellyn D. Howell (ed.), The Handbook of Country

and Political Risk Analysis. East Syracuse, New York: The PRS Group, pp.23-27.

On the basis of political system type identification, PRS analysts then assign risk points

up to a maximum of 12 points for:

i. Government stability

ii. Socioeconomic conditions

iii. Investment profile

iv. Internal conflict

v. External conflict

And up to a maximum of 6 points for:

i. Corruption

ii. Military in politics

iii. Religious tensions

iv. Law and order

v. Ethnic tensions

vi. Democratic accountability

vii. Bureaucracy quality

Other similar approaches are offered by the Business Environment Risk Intelligence, the

Economist Intelligence Unit, Standard & Poor’s Ratings Group and Moody’s Investor

Services. There are also a series of non-business related approaches developed by

agencies such as Transparency International as well as projects such as the Country

48 | P a g e

Indicators for Foreign Policy Project developed in Canada under the auspices of the

Department for National Defense.44 Unlike the pure business approaches, the latter two

techniques attempt to measure risk in relation to specific issues associated with probity,

corruption, and foreign policy affairs.

While nominally useful as a short-hand business / foreign policy tool, the accuracy and

utility of these methods is questionable. Indeed, many of the criticisms that can be leveled

at such approaches have already been noted. To what extent, for example, is political

instability an indicator of political risk? There is no measure or indices to assess policy

continuity / discontinuity or its effect upon foreign investment interests or to correlate

political system type with risk events. Indeed, the PRS approach appears to circumvent

its own utility, suggesting that political risk calculations are simply based “on the premise

that the more democratic the society is, the more accountable it is: and the more

accountable it is, the less susceptible it is to sudden or explosive political shocks.”45 If

such is the case, why utilize the PRS model since all it can indicate is that the less

democratic a political system the higher the risk environment.

Other problems also present themselves. How are factors like corruption and bureaucratic

quality assessed? How is the extent of military engagement in politics measured? What

criteria are used to make these determinations? Obviously, the entire PRS technique

relies on the assumptions made by analysts and on porous information requiring high

levels of interpretive discretion. Further, it does not appear that these determinations are

tested or stressed via any modeling technique to assess their accuracy. And, as also noted

previously by Robock, the PRS technique tends to measure macro-political risks but fails

44 Transparency International publishes annually a global corruption perception index as well “Bribe Payers Index”. These rank countries in relation to their institutional probity and propensity toward bribery <URL: http://www.transparency.org/>. The Country Indicators for Foreign Policy project was developed out of the Canadian Department of National Defence through the Norman Patterson School of International Affairs, Carleton University. See URL: http://www.carleton.ca/cifp/. Numerous other approaches are also reviewed by J.M. Chermak (1992), “Political Risk Analysis: Past and Present,” Resources Policy, 18(3), pp.173-176. The techniques for risk assessment and measure development by the Economist, PRS group, among others, are succinctly outlines and assessed in Llewellyn D. Howell and Brad Chaddick (1994), Models of Political Risk for Foreign Investment and Trade,” Columbia Journal of World Business, 29(3), Fall, pp.70-91. 45 Llewellyn D. Howell (2001), “International Country Risk Guide (ICRG), The PRS Group,” in Llewellyn D. Howell (ed.), The Handbook of Country and Political Risk Analysis. East Syracuse, New York: The PRS Group, pp.24.

49 | P a g e

to recognize that these are infrequent and that most risk events tend to be of a micro-

political type. However, the PRS technique has no indices for measuring micro-political

risk. In all, then, these techniques are impressionistic snap-shots that tend to define

political risk using problematic criteria and utilizing a poor information base requiring

high levels of interpretation and which produce relatively unsophisticated observations;

many of them without specific utility to various investment types.

Scenarios and Project Based Risk Assessment: Shell Corporation and Political Risk

Scenario generation has its origins in the Cold War when strategic analysts developed the

method for helping to think futuristically about driving forces, chains of events, or

possible trigger points that might lead to conflict between the Warsaw Pact and NATO,

and how, if this occurred, the conflict might proceed. In essence, scenario generation was

used to plot logically plausible possibilities and then to model responses, strategic

positioning strategies, and to formulate war-fighting and contingency plans. Cold War

scenario generation was said to be so successful in modeling circumstances of possible

nuclear confrontation with devastating and mass annihilation outcomes, that policy

makers were moved to develop the doctrine of MAD (Mutually Assured Destruction) and

various avoidance strategies to avert the possibility of nuclear confrontation.46

The essence of scenario generation is defined by Geoff Coyle as “a justified and traceable

sequence of events which might plausibly be imagined to occur in the future.”47

Importantly, scenarios are not “forecasts, preferences or predictions, but plausible,

challenging descriptions of what might happen—in the form of a set of stories about

alternative futures.”48 To this end, scenario analysis builds on many of the techniques of

the Delphi method. But rather than use intermediaries to design survey questionnaires,

identify experts and synthesize and interpret responses, scenario generation allows

46 Geoff Coyle (2003), “Scenario Thinking and Strategic Modelling,” in David O. Faulkner and Andrew Campbell (eds.), The Oxford Handbook of Strategy: A Strategy Overview and Competitive Strategy (Volume 1), Oxford: Oxford University Press, p.311. 47 ibid., p.309. 48 Angela Wilkinson and Esther Eidinow (2003), A Brief Introduction to Building and Using Scenarios,” Journal of Risk Research, 6(4-6), July, p.295.

50 | P a g e

experts to develop scenarios that lay bare assumptions and the rationale on which

interpretations are made, and to develop possible sketches of anticipated events and their

probable time lines. The thinking behind this is to allow those who utilize scenarios to

make informed decisions and to evaluate the scenarios generated relative to the

assumptions on which they have been based.

Apart from the military, some of the first institutions to employ scenario generation were

commercial organizations. The Royal Dutch Shell Company, for example, pioneered

scenario analysis under the auspices of three prominent individuals, Peter Schwartz, Kees

van der Heijden and Peter Checkland.49 However, despite some 30 years of scenario

generation no formal models exist; indeed the notion of formal techniques is actively

resisted. Rather, scenario generation stresses creative, imaginary, challenging discourses

about possible futures by looking at the dominant drivers of societal change and risk.

These are normally categorized under the well known PEST acronym (political,

economic, social and technological factors) as the primary drivers of change and risk, and

primary determinations of future worlds, processes and events.

Scenarios, however, are not used to write the future but to outline possibilities in relation

to key decisions that need to be taken today and of the possible future implications of

these decisions given a constantly changing environment. It is, in this sense, an attempt to

map possible trajectories and outcomes and logically construct images of cause and effect

so that the ramifications of decision making can be understood in terms of its collateral

implications and consequences. Peter Schwartz encapsulated the process with the

provocative title of his book: The art of the Long View.50

49 Peter Checkland (1999), Soft Systems Methodology: A 30 year Retrospective. Chichester: John Wiley; Kees van der Heijden, Ron Bradfield, George Burt and George Cairns (2002), The Sixth Sense: Accelerating Organizational Learning with Scenarios. John Wiley & Sons; Peter Schwartz (1991), The Art of the Long View: Planning for the Future in an Uncertain World. Doubleday. 50 Peter Schwartz (1991), The Art of the Long View: Planning for the Future in an Uncertain World. Doubleday.

51 | P a g e

The precise methods associated with scenario generation are numerous and the method

employed normally contingent on the intended purpose. Angela Wilkinson and Esther

Eidinow, for example, suggest that scenario generation falls into four discrete categories:

1. Deductive Methods: Structured framework approach; clearly identified

objectives, known constitutive / environmental elements; formally mapped

trajectories; scenarios generated.

2. Inductive Method: Development of a series of scenarios from an

assemblage of a series of possible events.

3. Incremental Approach: Develops images and maps and describes an

“official future”—or the one the organization thinks most likely to emerge,

and then develops scenarios on the basis of decisions and how they will

interact with the “official future” and their possible consequences and

effects.

4. Normative Approach: Starts with a set of characteristics of assumed

conditions, or a scenario framed in a forward time horizon, and works

backwards to see what it requires (decisions, events, processes, attributes)

to get there and if this is feasible.51

Peter Schwartz suggested that just as novels have themes which provide continuity,

logical connections, and thus a central narrative enabling interpretation and assessment,

scenarios too need a theme. But what? Schwartz suggested several themes; challenge and

response, for example: “Perhaps London’s position as a centre for financial services is

challenged by Frankfurt or Tokyo; what are the drivers and uncertainties which will

affect the viability of a strategic response?” Other themes suggested included winners and

losers or infinite possibility. The theme is not important per se, but a tool providing a

51 Angela Wilkinson and Esther Eidinow (2003), “A Brief Introduction to Building and using Scenarios,” Journal of Risk Research, 6(4-6), July, p.296.

52 | P a g e

catalyst or fulcrum via which to stress test the assumptions, the logicality of outcomes,

the implications of strategic decisions and the risks and opportunities that might present.

As with other third generation approaches, scenario analysis is not a panacea, offering

both insights but also displaying limitations. It embraces lateral creative thinking and

challenges organizations (commercial, non-commercial and state based) to think about

alternative futures or events otherwise not anticipated. To the extent that it is able to do

this successfully, it has obvious advantages for contingency planning, risk identification,

mitigation planning and risk avoidance. It thus helps various commercial, state and non-

commercial actors to navigate uncertainty and risk environments rather than stumble

upon them without due thought to management and response. The normal caveats about

such approaches apply, however: the quality of the analysis is directly proportionate to

the quality of the analysts; interpretative discretion if not managed and appropriately

tested and checked, can derail the construction of quality scenarios and their utility.

Beyond Third Generation Approaches:

A Fourth Generation of Political Risk Assessment Techniques?

If second generation approaches proved mostly inadequate as theoretical fiats for

assessing, analyzing and predicating political risk, the move toward particularistic micro

studies generally reliant on qualitative techniques and emblematic of third generation

approaches has also proven unedifying for many theorists. Qualitative approaches remain

reliant upon the agility and expertise of particular analysts, and the method of analysis

often deductive and not easily falsifiable or testable. The limitations of such approaches

are obvious to all, especially governmental and commercial organizations whose need for

more definitive and less qualified analyses is often acute. The holy-grail of political risk

theorizing; constructing quantitative models that can provide testable propositions, or the

construction of date-sets that can relate accurate probability indices to specific risk events,

policy changes, or country settings, thus remains a highly priced goal despite the

considerable obstacles that realizing such theory and data sets entails.

53 | P a g e

Not surprisingly, the quest for such perspectives has continued despite numerous setbacks.

Work by Jeffrey Frankel and Andrew Rose in 1996, for example, attempted to use

macroeconomic data to predict currency market volatility and stability. While successful

99.4 percent of the time predicting month-by-month periods of stability for a given

currency, they were only able to predict correctly 7.2 percent of periods in which severe

currency destabilization occurred.52 Extrapolated into macro-political databases able to

predict political events such as policy changes or reversal, instability, social unrest, or

attitudinal changes, then the magnitude of the problem becomes even more difficult. In

July 1997, for example, “a widely-used market measure of country risk––the risk

premium on the country’s sovereign bonds––identified the Czech Republic as a more

risky investment location than Indonesia.” Only a few months subsequently Indonesia

was to experience widespread instability, countless policy crises and disruptions to trade

and financial flows, country-wide political instability and ultimately regime change,

making a mockery of nearly all political risk forecasts, many from widely respected

assessment agencies.53

The track record of such political risk measures is thus not impressive. The reasons for

this are readily identifiable. Indices measuring investor perceptions, for example, are

generally formed on the basis of current issues and impressionistic snap-shots of

contemporary events rather than longer-term appraisal of shifts in policy, government and

institutional capacity, changing political coalitions or external conditions. Likewise, with

macro-economic data and country specific accounting information, both are open to wide

interpretation as to there meaning but also to political manipulation. China’s “official”

national accounts, for example, are widely discounted because of issues about the

efficacy of their data collection techniques, the lack of independent statutory accounting

bodies free of political interference, and because of outright manipulation of national

accounts by political interests. Similarly, macro-political data that simply attempts to

equate risk with regime instability is, as we have noted previously, tantamount to be

52 See Jeffrey J. Frankel and Andrew K. Rose (1996), “Currency Crashes in Emerging Markets: Empirical Indicators,” Working Paper (C96-062), Center for International and Development Economics Research (CIDER), University of California at Berkeley. 53 Sam Wilkin (2000), “Why Political Risk is Important to You,” World Trade, 13(3), March, p.42.

54 | P a g e

measuring the wrong indicator. On the basis of this system of measurement analysts

might be led to conclude that the regime stability displayed by Zaire, which had no

change in the executive composition of government between 1967-1994, represents a

lower level of risk for investors and international actors alike compared to Italy, which

had twenty-one leadership changes during the same period!54

Is there a way beyond this impasse? Can meaningful data sets be generated that

successfully correlate risk with structural features in the political composition and

political practices of nation-states, their institutions and the cultural / procedural norms

that comprise their markets, social, political and juridical systems? This question sets a

highly challenging task for theorists. It involves the construction of data sets that allow

analysts to examine the relationship between political and economic institutions, the

interface between domestic norms, actors, institutions and external influences and

participants / investors, and to understand the causal connections between all these

spheres in terms of probabilities about their implications for country and political risk

events in the present and immediate future.

POLCON: Political Risk as Political Constraint

Despite the enormity of the challenge this poses, considerable theoretical advances have

been made in the last several years. The insights offered by Raymond Veron’s

obsolescing bargaining model, for example, along with the spate of studies that followed

and which essentially attempted to understand changes to a unilinear bargaining

relationship between an investor (MNE) and a government by tracing changes in relative

bargaining power and actor preferences, has now been supplemented with more complex

theoretical formulations.55 Witold Henisz and Bennet Zelner, for example, develop a

dynamic model which, rather than seeing the government in a host environment as a

54 Witold J. Henisz and Bennet A. Zelner (ND), “Measures of Political Risk,” Mimeo, The Wharton School, University of Pennsylvania. 55 Raymond Veron (1980), “The Obsolescing Bargain: A Key Factor in Political Risk,” in Mark B. Winchester (ed.), The International Essays for Business Decision Makers. (Volume 5) Houston: Center for International Business, pp.281-286. See also Raymond Vernon (1977), Storm Over the Multinationals: The Real Issues. Boston: Harvard University Press.

55 | P a g e

singular agent or unitary actor, complicates the bargaining relationships and policy

making processes by adding several layers; interactions between foreign investors,

domestic interest groups, government agencies and political actors. Moreover, for Henisz

and Zelner each of these groups is recognized as facing cognitive limitations, what they

refer to as “informationally impacted” or “boundedly rational”, with each differing in

their preferences and subject to varying normative pressures and institutional

constraints.56

The outcome of such a model is a more complex appreciation of the institutional nature

of government, policy and decision-making, and of the interface between regulatory

bodies, foreign commercial and other stakeholders. Indeed, for Henisz and Zelner, it

proscribes a different set of policy recommendations for management of political risk

exposures which, rather than exploit an MNE’s strong initial bargaining power through

frontloading their returns, suggests that they exercise caution “by negotiating for

regulative institutions that balance profitability with legitimacy” in order to insulate

against future interest group pressures, or at least moderate the demands of domestic

constituencies on government to claw back rents from foreign investors.57

Henisz and Zelner are among an emerging strand of scholars who might loosely be

defined as neo-institutional theorists and who move beyond statism and its

unsophisticated focus on “government” to address the role of institutions and the

institutional environment. For them, institutions and the policy, regulatory and

governance structures they comprise, are understood as part of the dynamic risk

environment that international investors and other actors must interface with when

dealing with foreign governments. The point, for Henisz and Zelner, however, is that

understanding this interface and the constraints and enabling forces that operate on each

of these actors in the bargaining process, is the place where theory needs to evolve and

56 Witold J. Henisz and Bennet A. Zelner (2002) “Legitimacy, Interest Group Pressures and Institutional Change: The Case of Foreign Investors and Host Country Governments,” Working Paper (WP 2002-08), The Reginald H. Jones Center, The Wharton School, University of Pennsylvania. 57 ibid., p.6, 20-23. See also Witold J. Henisz (2000), “The Institutional Environment for Multinational Investment,” Working Paper (WP 2000-01), The Reginald H. Jones Center, The Wharton School, University of Pennsylvania.

56 | P a g e

where empirical data sets need to be constructed if effective political risk measures are to

be developed. The problem, of course, is that it is precisely here where too little concrete

data exists and where too little theoretical effort has been applied. Previous studies, for

example, while demonstrating broad correlations between political institutions and cross-

national variation in private investment and growth patterns, have not been able to

identify which political institutions matter and, specifically, which institutional feature is

of significance in terms of political risk.58

The way beyond this problem for Henisz is simple, at least when political risk is

understood in the context of the obsolescing bargaining dilemma and a function of the

changing balance of power between investors and governments: measure political

constraints on governments to initiate policy change. The hypothesis for Henisz is that:

“the feasibility of policy change produces uncertainty and lower levels of investment and

growth.” The higher the level of constraints that operate on governments and decision

makers to modify the market environment, renegotiate contracts, or reengineer market

parameters and somehow affect the economic circumstances under which the initial

investment was made, the lower will be the political risk investors face.59

Henisz thus constructs a political constraints index (POLCON) of 157 countries assessing

the “number of independent veto points over policy outcomes and the distribution of

preferences of the actors who inhabit them.”60 In essence, Henisz constructs an abstract

model that basically looks at the ratio of checks and balances on discretionary political /

institutional decision making in each of these countries, such that the more institutional

heterogeneity displayed by the political system, the greater will be the policy continuity

because of the checks and balances on discretionary governmental / executive decision

58 Witold J. Henisz (2000), “The Institutional Environment for Economic Growth,” Economics and Politics, 12(1), March, p.3. See, for example, Rafael La Porta, et al., (1997), Legal Determinants of External Finance,” Journal of Finance, Vol. 52, pp.1131-1150; Stephen Knack and Phil Keefer (1995), “Institutions and Economic Performance: Cross Country Tests Using Alternative Institutional Measures,” Economics and Politics, Vol.7, pp.207-227; Mancur Olson (1996), “Big Bills Left on the Sidewalk: Why Some Nations and Rich and Others Poor,” Journal of Economic Perspectives, Vol. 10, pp.3-24.Ted R. Gurr (1989), Polity II Codebook. Center for Comparative Politics. Boulder, Colorado. 59 Witold J. Henisz (2000), “The Institutional Environment for Economic Growth,” Economics and Politics, 12(1), March, p.5. 60 ibid., p.5.

57 | P a g e

making. For Henisz, such checks and balances are constituted by both “de jure

characteristics such as constitutional separation of powers as well as de facto

characteristics such as the extent of partisan heterogeneity within and across branches of

government.”61 Immature, structurally “thin” regimes with highly concentrated power

structures and few veto points or opposing decision-making entities, score low on

Henisz’s POLCON index suggesting greater latitude for policy change, while structurally

complex, “thick” political systems like federal systems with numerous veto points and

diffuse power / decision making structures, score higher on the POLCON index and thus

are less prone to policy change. Why? As Henisz and Zelner note, “institutional

configurations with stronger checks and balances require agreements across a broader

range of political actors to effect a shift in policy, increasing the effort required of any

given political actor to change their existing sector-level regulative institution.”62

While Henisz and Zelner claim independent empirical evidence supporting their findings

and model, the utility of the approach at least for general political risk assessment

remains to be seen.63 Certainly it represents a significant advance in political risk

measurement systems especially since it moves away from the assessment of country-

wide political system types indicative of second generation approaches and, instead,

embraces micro-political assessments focused on industry and sectorial specific segments

of economies. This addresses one of the biggest problems identified by Kobrin and

Robock; that country risk was not a suitable risk indicator for the risk environments of

firms since risks are experienced differently from industry-to-industry.64 In that sense,

Henisz is right to claim that his approach is innovative because it represents a

contribution to:

61 Witold J. Henisz and Bennet A. Zelner (2002) “Legitimacy, Interest Group Pressures and Institutional Change: The Case of Foreign Investors and Host Country Governments,” Working Paper (WP 2002-08), The Reginald H. Jones Center, The Wharton School, University of Pennsylvania, p.24. 62 ibid., p.24. 63 ibid., p.25. 64 See Stephen J. Kobrin (1979), “Political Risk: A Review and Reconsideration,” Journal of International Business Studies, Vol. 10, pp.67-80; Stefan H. Robock (1971), “Political Risk Identification and Assessment,” Columbia Journal of World Business, Vol. 6, pp.6-20.

58 | P a g e

…the transition of the empirical macro-political economy literature from macro-

macro (using existing political science measures to predict national variation in

macroeconomic outcomes) to micro-micro (identifying and measuring the

economic impact of specific constellations of political institutions and preferences

at an industry, firm or transaction level).65

Despite this, Henisz’s highly specific conceptualization of political risk and the

measurement system erected to assess this is not immune to questions of appropriateness

and utility. First, for example, the narrowness with which political risk is defined, i.e., as

the propensity for policy change re foreign investors, is problematic. Policy change is

normatively ascribed a negative connotation, when in fact policy change might be

enabling to investors or particular investment projects. Indeed, policy inertia or high

levels of constraints on policy change might be indicative of either non-responsiveness to

the demands of domestic consistencies thus fuelling political resentment, possible

political disquiet or electoral instability. Further, this might be prescient to subsequent

regime / government change and or more dramatic policy shifts of larger magnitudes as a

reaction to prolonged policy inertia. Or, as the case may be, policy continuity might be

indicative of poor institutional capacity; the inability to initiate domestic reform,

liberalize markets, innovate the economy, or respond to needed reforms. Ineffective

governance structures and dysfunctional political systems can all contribute to policy

“stability” in as much as securing policy change or innovation might be politically

impossible in a political system that is essentially stalled. As Henisz himself is forced to

admit, “constraints provided by …institutional and political factors may also hamstring

government efforts to respond to external shocks and/or to correct policy mistakes.”66

Indeed it might, as well as hamstring government responding to the concerns of foreign

investors or other external actors seeking policy assurances or redress for perceived

grievances.

65 Witold J. Henisz (2000), “The Institutional Environment for Economic Growth,” Economics and Politics, 12(1), March, p.23. 66 ibid., p.4.

59 | P a g e

The problem, then, as with previous political risk measurement systems is whether in fact

political constraints and the corollary of policy stability is in fact the variable that needs

measuring? Can this be correlated with political risk as a suitable indicator of the risk

environment of host states? If it can, does the micro-micro level of analysis suggested by

Henisz preclude adequate consideration of the macro-structural features of political

system types as a whole? Indeed, can the POLCON index give a false reading by

suggesting policy continuity while on the macro-political side of things policy inertia

witnesses growing political disquiet possibly expressed subsequently with radical

electoral changes and large policy shifts? And what of the quality of the data utilized to

construct the POLCON index? There are anomalies as Henisz acknowledges. While, for

example, primary data would indicate that at the time of the Asian financial crisis

Malaysia had an independent legislature splintered by a series of political parties and thus,

apparently, a series of formal veto points acting on the executive, in practice the

“government party controlled many of the ostensibly independent parties.”67 How

reliable, then, can empirical data sets be when the nuances of such blurred political

practices cannot be captured by empirical constructs? Further, in what sense is political

heterogeneity a genuine veto point if, as Henisz acknowledges, “the collective nature

of…[a legislative body]…may well mean that partisan checks and balances are less

effective than those provided by freestanding institutional actors such as regulatory

agencies or judiciaries.”68 What do we measure if not partisan heterogeneity? Perhaps

institutional structures such as statutory regulatory bodies or judicial structures? But even

here Henisz sounds a note of caution by suggesting that these regulatory bodies and

judiciaries “if not monitored or constrained by other governmental bodies” are also

“prone to corruption and…likely to be more susceptible to interest group pressures…”

circumventing their role as a veto point insuring policy continuity. 69 The fact that

regulatory or judicial institutional structures might be in place in a political system does

not tell us about the probity of the institutions themselves––a key facet the POLCON

index is not able to measure.

67 Witold J. Henisz and Bennet A. Zelner (2002), op.cit, p.26. 68 ibid., p.26. 69 ibid., p.26.

60 | P a g e

The point is not to discredit Henisz extremely insightful and useful POLCON index

system but to highlight its limitations. Empirical constructs of this sort must always

abstract and simplify complex political practices, often in ways that are not able to

capture the varied practices between political systems, their institutions and political

cultures. All of which leads Henisz to acknowledge that the various veto points and

checks and balances “must be scrutinized” beyond a raw calculation of the data if an

accurate understanding of policy continuity is to be gained. Again, this suggests stepping

outside of the POLCON measurement system and reflecting on its limitations––or at least

second guessing the efficacy of the data its generates and its objects of measurement. Can,

for example, measures of other variables tell us as much or perhaps more about policy

continuity and change? Studies by Philip Keefer and Stephen Knack of the World Bank

ascribe policy continuity and change not to veto points as a result of de jure or de facto

institutional structures but, rather, to the degree of socio-political and ideational

polarization in a society on specific issue areas; the greater the level of polarization the

more likely are radical policy shifts as a result of electoral changes to government and the

less likely are consensus driven policy changes:

The greater the differences between the two groups, and the greater the

uncertainty about the other group, the larger are the gains to stubbornness, or

continued disagreement about collective decisions. This . . . polarization impedes

the formation of consensus to change policy. As a consequence, exogenous

shocks trigger large swings in economic outcomes, because government policy

makers cannot agree on any compensating policy changes.70

Is, then, polarization a greater indicator of political risk and a better object of

measurement than veto points and various institutional checks and balances?

Finally, while Henisz’s POLCON index might provide useful information for prospective

commercial investors into foreign countries, its utility as an indicator of political risk for

70 Philip Keefer and Stephen Knack (2000), “Polarization, Politics, and Property Rights: Links between Inequality and Growth,” Public Choice, World Bank Policy Research Working Paper 2418, August, p.3.

61 | P a g e

non-commercial actors is limited. Foreign policy makers or trade negotiators, for

example, might be puzzled by indices which ostensibly measure policy or political

intransigence. With political risk defined so narrowly, broader questions about the

institutional environment, its stability, capacity to absorb shocks, adjudicate sectional

interests, manage competing political interests and achieve legitimacy, are beyond the

scope of the POLCON index.

The World Bank, CHECKS and the Data Base of Political Institutions (DPI)

Despite the many methodological questions that might be raised of political risk

measurement systems such as the POLCON index, they nonetheless continue to prove

attractive not least because they are able to generate cross-national comparisons that

provide firm estimations of the risk environments commercial actors might face. The

efficacy of such approaches is thus not in question, only the search for better

methodological tools and more robust empirical data sets to improve their accuracy.

For fourth generation political risk researchers, the problem most often stated is that

“cross country empirical work has been handicapped by a lack of detailed data on

countries’ political and institutional characteristics and on how they change overtime.”71

The result has been comparative political economy work based on a small sample of case

studies that, while important, have not provided the means for generalizing research

findings or producing the types of risk measurement systems sort after by commercial

and non-commercial actors alike.

One such attempt to overcome this dilemma is the database of political institutions (DPI)

project compiled by Thorsten Beck and Philip Keefer (among others) at the World

Bank’s Development Research Group. The research agenda is ambitious: to unearth

“which institutions are most conducive to development and reform” and “under what

71 Thorsten Back et al., (2001), “New Tools in Comparative Political Economy: The Data Base of Political Institutions,” The World Bank Economic Review, 15(1), p.165.

62 | P a g e

conditions do such institutions emerge?”72 For the World Bank, answers to these basic

but highly complex questions harbor obvious utility for growth and development

strategies. For political risk analysts, the database also holds interest, not least because it

can help reveal comparative differences between national political structures, political

decision-making mechanisms and national characteristics, and thus help profile specific

policy making and institutional features prone to risk.

The DPI is thus designed as a first step to develop a comprehensive database of the

institutional characteristics of some 177 countries comparing 113 variables between

1975-2000; variables addressing specific issues about a country’s “elections, electoral

rules, type of political system, party composition of the opposition and government

coalitions, [and] the extent of military influence on government.”73 Unlike other

databases, however, the distinctiveness of the DPI database is its depth; developing sub-

indices, for example, about the level of electoral competitiveness in a country, the policy

preferences of ruling coalitions and oppositions, and the ideological leanings of decision-

makers. In addition, the World Bank’s DPI provides data on the length of tenure and

turnover of governments as well as basic information about candidature selection rules.

The DPI also takes account of the structural characteristics of political systems,

especially the effect of sub-national structures on national level policy making and thus

has several “variables to capture the extent of federalism in a country’s political structure;”

whether the country has autonomous self governing regions; degree of localization for

regional elections, and the juridical reach of regional governments.74 Finally, the DPI

constructs an index of political cohesion in an attempt to measure the various checks and

balances operative on national political decision-making. It does so through the

construction of three new indices, the CHECKS1, CHECKS2, and now CHECKS3

indices. These count “the number of veto players in a political system, adjusting for

whether the veto players are independent of each other, as determined by the level of

72 ibid., p.165. 73 Thorsten Beck, et al., (2000), “New Tools and New tests in Comparative Political Economy: The Database of Political Institutions,” Working Paper (Number 2283), The World Bank, Research Development Group, Washington, D.C., February, p.2. 74 Thorsten Back et al., (2001), op.cit., p.170.

63 | P a g e

electoral competitiveness in a system, their respective party affiliations, and the electoral

rules.”75

The DPI does not itself generate findings but provides an analytical tool allowing

researchers to utilize the data in ways that can generate genuine cross-national

comparisons of how political institutions and various institutional permutations impact

decision-making, the economy, growth, development and investment. As Witold Henisz

notes, “while the economic impact of political institutions is generally accepted,

economists, private investors and policy-makers are only [now] beginning to unpack the

question of which political institutions matter; how they effect macroeconomic outcomes;

and how they influence business decisions.”76 The DPI thus represents a significant step

in that direction, one of the first comprehensive empirical attempts at data collection with

a level of specificity and depth not previously available to political risk analysts. In doing

so, it represents the emergence of a fourth generation of political risk research and a

return to questions about the role of political institutions on the economic composition

and articulation of economic practices and markets in nation-states.

New Forth Generation Approaches

The World Bank’s DPI project is not alone in this respect, however. Perhaps as a result of

information data profusion doubtlessly associated with advances in information

technologies, numerous attempts are now being mounted to develop risk databases that

attempt to correlate and or identify specific trigger points with particular risk events;

events such as humanitarian crises, state failure and ethic conflict, for example. Not

unnaturally, much of the most interesting of this work is being done in the foreign policy

and international relations fields. Here, projects as diverse PIOOM (Interdisciplinary

Research on the Root Causes of Human Rights Violations); GIEWS (Global Information

and Early Warning System) assessing food security and trigger points for hunger and

famine; GEWS (Global Early Warning System; GEDS (Global Event Data System);

75 ibid., pp.169-170. See also Philip Keefer (2000), “DPI2000 Database of Political Institutions: Changes and variable Definitions,” World Bank, March < http://www.worldbank.org/research/bios/pkeefer.htm> 76 Witold J. Henisz (2000), op.cit., p.23.

64 | P a g e

FAST (Early Recognition for Tension and Fact Finding); ICG (International Crisis

Group); and the American USAID’s Impact Assessment––Participatory Country Program

Strategic Planning and Performance Monitoring, Field Manual, are all attempts at

developing systematized methodologies for identifying trigger points prescient to various

international risks associated with food security and famine, ethnic and religious tensions,

civil conflict, inter-state hostilities, energy crises and environmental sustainability.77

Many of these organizations are involved in preliminary data collection, seeking to

establish sufficient data in order to develop leading indicator models able to identify

which sequence of events or triggers are precursors to regime instability, conflict,

humanitarian crisis, or any series of other severe events. One of the more innovative, for

example, the Country Indicators for Foreign Policy (CIFP) run by David Carment, has

grown out of a geopolitical database originally developed by the Canadian Department of

National Defence in 1991.78 Intended as a lead indicator tool for decision makers in

government, NGOs and the private sector, the CIFP project is an on-going data collection

effort “to identify and assemble statistical information conveying the key features of the

political, economic, social and cultural environments of countries around the world. . . [in

order to provide] . . .global overviews, issue-based perspectives and country performance

measures.”79 Much like the World Bank’s DPI the CIFP includes statistical data and

measures of “domestic armed conflict, governance and political instability, militarisation,

religious and ethnic diversity, demographic stress, economic performance, human

development, environmental stress, and international linkages . . . in the form of over one

hundred performance indicators for 196 countries, spanning fifteen years (1985-2000).”80

77 See PIOOM (Interdisciplinary Research on the Root Causes of Human Rights Violations) < http://www.fsw.leidenuniv.nl/index.php3?c=149>; GIEWS (Global Information and Early Warning System) < http://www.fao.org/giews/english/index.htm>; GEWS (Global Early Warning System) < http://fugimodel.t.soka.ac.jp.FUG/chapter6/chapter6.html>; GEDS (Global Event Data System) < http://geds.umd.edu/geds/>; FAST (Early Recognition for Tension and fact Finding) < http://www.swisspeace.org/fast/default.htm>; ICG (International Crisis Group) < http://www.icg.org/redirect.cfm>. 78 See the Country Indicators for Foreign Policy <http://www.carleton.ca/cifp/>. 79 David Carment (2003), “Country indicators for Foreign Policy: Final Report Phase III,” February <www.carleton.ca/cifp>, p.3. 80 ibid., p.3

65 | P a g e

The novelty of CIFP projects rests in its ambitions to move beyond risk analysis into a

fully fledged early warning system prescient to various crises that confront Canada’s

humanitarian, conflict prevention and human security centered approach to international

affairs. Part of this has involved the development of a modeling technique for assessing

country risk based on a cross-national “index of severity”. The index, however, is not

simply a straight cross-national comparison between states but an indices of relative

performances between states in order to better identify areas of stress that night be

triggers for risk and crisis. As Carment notes:

The index of severity is based on the assumption that there is a logical connection

between state performance and changes over time such that there is a need to

separate out the absolute development of a state’s capabilities within the

international system, and the relative development of a state’s capabilities within

the international system. Whereas the former process will always be

unidirectional (though reversible) as a state develops (or regresses) over time, the

latter process is going to be curvilinear because a state’s performance is being

measured against other states in the international system which will or will not be

developing at a more rapid pace

While seemingly obvious, the insights of Carment’s and the CIFP Index of Severity is its

ability to develop indices measuring the relative performance of a state’s capabilities

rather than simply generating cross-national comparisons based on absolute performance

indicators. The importance of this analytical innovation lies in it developing more

prescient indices:

. . . the proper referents for understanding the severity index are not only a state’s

own past, present and future performance in absolute terms but its performance

relative to other states at any given point in time. The rate of change (which is

understood by examining a state’s relative performance as opposed to absolute

performance) whether progressive or regressive tells us whether a state is moving

towards collapse or improvement. In other words, characteristics and indicators

66 | P a g e

are useful for defining severity only if there are appropriate reference cases from

which to compare. And since these reference points are themselves evolving over

time it is important to understand that “risk potential” is a relative term and has

meaning only with respect to state performance at specific points in time.81

With this important innovation and caveat, the CIFP severity index develops a weighted

index of nine composite risk indicators (armed conflict, governance and political stability,

militarisation, population heterogeneity, demographic stress, economic performance,

human development, environmental stress and international linkages). In addition, each

of these composite indicators can be related to any combination or all of the other

composite indicators (to a maximum of 72 potential linkages). The severity index thus

assigns a weight to each indicator “based on the number of linkages it is expected to have

with others and thus its input into over all severity.”82

Similar humanitarian early warning systems are also being evolved by organizations like

the International Crisis Group (ICG) whose network of country and regional based

representatives across five continents, maintain continual monitoring protocols based on

“field analysis and high-level advocacy to prevent and resolve deadly conflict.”83 Peace

researchers in the Netherlands and Scandinavia are likewise working toward early

warning modeling based on collecting sufficient data and evolving trigger point

identification techniques.84

Such lead indicator modeling approaches and early warning systems harbor obvious

utility for various aid agencies, NGOs, international organizations, as well as

governmental bodies. If perfected, they can provide vital and timely information helping

avert humanitarian crises, ethnic conflict or inter-state hostilities. They thus have

enormous practical utility in terms of pre-emptive decision-making, humanitarian disaster

81 David Carment (2001), “Assessing Country Risk: Creating an Index of Severity,” Background discussion paper prepared for CIFP Risk Assessment Template, May <www.carleton.ca/cifp>. 82 ibid., p.5 83 See the International Crisis Group (ICG) < http://www.crisisweb.org/home/index.cfm> 84 See <http://www.fsw.leidenuniv.nl/index.php3?c=149>

67 | P a g e

preparedness and conflict avoidance. In contrast to second generation approaches that

attempt to develop abstract typologies of political systems in terms of their risk

characteristics vis-à-vis regime stability, social unrest or conflict propensity, fourth

generation approaches are far more specific and actively seek to correlate particular

institutions, trigger points, or event sequences and stresses to particular decision making

practices, crises and outcomes. This represents a level of micro-institutional analysis that,

if successful, will be able to correlate institutional type to the probability of risk events,

or a sequence of events, stresses, strains and relative capability performances, to crisis

episodes and conflict outcomes––a level of analytical precision that always escaped

second generation approaches.

While still in their formative stages, fourth generation political risk approaches have

spurned a renewed excitement about the potential of finally gaining greater analytical

precision and of identifying which institutions matter, how they affect risk episodes and

the societal risk environment. This obviously opens up the possibility of institutional

engineering to help ameliorate all manner of economic and political ills; economic

development and growth, enhancing institutional capacity and effective public policy

delivery, increasing public sector resource efficiency, as well as contributing to better

institutional probity and administrative transparency. In doing so, some of the great

conundrums of political risk analysis and forecasting stand to benefit greatly and enjoy a

micro-analytical revolution long overdue.

Political Risk Analysis—Where to Next?

Third generation political risk analysis is an outcome of two reinforcing trends: the

failure of second generation approaches, specifically of political scientists, to develop

accurate forecasting systems for political risk based on political system type and, second,

the enormous growth in transnational capital flows and FDI since the 1960s, which, by

force of sheer volume, continues to pose practical economic and commercial demands for

political risk measurement systems. While third generation approaches have responded to

these trends by abandoning systemic political analysis in favor of contextual, qualitative

68 | P a g e

approaches geared toward micro-analysis or project based assessment techniques, they

have not managed to attract a critical research mass or methodological core around which

common techniques and approaches have evolved. Rather, third generation approaches

tend to be mired by a multifarious array of disparate political risk measuring systems,

techniques and methods. None enjoy intellectual supremacy and all suffer from

limitations mostly as a result of porous and imperfect information, historically

constrained data sets, or by technical limitations as a result of reliance on “expert”

knowledge and qualitative, subjective assessment techniques.

By contrast, fourth generation approaches to political risk analysis represent a maturation

of analytical techniques and a return to a core, central research agenda; data collection,

improving data depth and developing comparative data sets combined with institutional

analysis to understand broadly the effect of political institutions on the composition of

national economies, markets, investment and the activities of business. These

developments are significant since they represent a return to more traditional analytical

techniques informed broadly by positivist epistemologies, institutional analysis, and

deductive theory open to empirical and observational based validation methods. They

also mirror the growth in political economy perspectives in international relations and

political science generally, as well as the institutionalist turn in political science

emblematic of broader debates surrounding the new institutional economics.85 Political

risk analysis is thus set for a long overdue theoretical overhaul, the outcomes of which

promise to deliver better analytical techniques with greater precision and thus greater

utility.

85 See, for example, Douglas C. North (1990), Institutions, Institutional Change, and Economic Performance. New York: Cambridge University Press; Douglas North (1997), The Contribution of the New Institutional Economics to an Understanding of the Transition Problem. Wider Annual Lecture, World Institute for Development Economics Research; Oliver Williamson (1987), The Economic Institutions of Capitalism: Firms, Markets and Relational Contracting. The Free Press. The specific relevance of the new institutional economics to international business and political science is addressed, respectively, by Elizabeth maitland and Stephen Nicholas (2004), “New International Political Economy: Moving Beyond management Towards International Studies,” Paper presented to the Academy of International Business, Stockholm, June 10-13; Linda Weiss (2004), “Institutional Analysis in International Political Economy and its Relvance for the Study fo International Business,” Paper presented to the Academy of International Business, Stockholm, June 10-13.