Вы находитесь на странице: 1из 69

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
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.

1|Page
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.

2|Page
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.

3|Page
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.

4|Page
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.

5|Page
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).

6|Page
Figure 1.1
Political Risk Typology Defined by Praxis Ontology
Praxis Area Description of Level(s) of Assumed Major End
Praxis Analysis Dominant Risk Users
Application Drivers /
Actors / Agents
/ & Processes
International Country risk International, Government and MNEs, banks,
Business Risk analysis / domestic, sub- quasi fund managers,
Analysis macro- national, local, government credit ratings
economic and project based, agencies / agencies,
macro-political individuals regulatory and forecasters,
forecasts / statutory bodies/ insurance
project based judiciary / legal underwriters,
risk assessment system/ foreign direct
/ share holder bankruptcy investors
due diligence protection laws
reports/ legal /corruption /
liability & cronyism /
indemnity nepotism / JV
assessment partner(s) /
policy continuity
/ political
stability / civil
unrest /
governmental
transparency /
Public Sector Institutional Domestic Adequacy of Government /
Risk Analysis analysis / (national) / institutional Public sector
institutional sub-national capacity / policy agencies /
capacity actors – formation and international

7|Page
building/ statutory bodies assessment development
institutional / quasi- process / agencies (IMF,
development government institutional World Bank,
and innovation / agencies / resource International
public sector regulatory availability / Financial
efficiency authorities level of probity Corporation,
enhancement and institutional Asian
/public sector transparency Development
outcomes /institutional Bank, OECD,
enhancement accountability etc.) / NGOs /
/regulatory mechanisms citizens groups
management /independence and not for
/prudential of statutory profit watch
reform / costing bodies / dogs
and efficiency extensity of
analysis political bias,
political
patronage,
nepotism
/human resource
and skill
capacity / extent
of institutional
learning and
adaptability

Policy Risk Policy Predominantly Policy Lobby groups /


Analysis implications for domestically implementation special interest
stakeholders focused but processes and groups /
/impact some mechanisms / political action
assessments / internationally political and committees /

8|Page
industry focused (e.g., institutional industry &
position papers / trade and decision makers consumer
market – sector finance issues) / relevant groups
– industry regulatory
composition agencies or
analysis / oversight
projection committees
analysis
International Threat Global, Nation-states Government
Risk Analysis assessments and regional, /rogue states / and
projections/ international sub-national government
economic and domestic actors like agencies / law
security and sub- terrorists and enforcement
assessment / national terrorist agencies /
intelligence networks, political
assessments / separatist scientists /
terrorist analysis movements, defense
/ humanitarian transnational planners /
crisis and domestic intelligence
assessment / criminal agencies /
international networks / armed forces /
crisis political NGOs / foreign
management / instability / civil policy decision
security and war / coups / makers /
defense military and advocacy
assessment / civilian groups and
defense, dictatorship think tanks
security and
foreign policy
planning and
positioning

9|Page
strategies

10 | 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.

11 | 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

12 | 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

13 | 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).

14 | P a g e
Figure 1.2
Prxiological Interrelationship of Risk Analysis

International International
Risk Analysis Business Risk
Analysis

Public Sector
& Institutional
Risk
Analysis

Policy Risk
Analysis

15 | P a g e
Figure 1.3
Political Risk: Generative Drivers

Interdependence

Domestic International
Environment Environment

Political Risk
Drivers

Institutional Policy
Environment Environment

Globalization

16 | 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.

17 | 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.

18 | 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.

19 | 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.

20 | 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

21 | 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.

22 | 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.

23 | 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.

24 | 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.

25 | 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 Features Examples Political Political
Type Risk Instability
Instrumental High level of political transparency; United States; Low Low
Adaptive political system displays high levels United

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.

26 | P a g e
Systems of legitimacy; embedded political Kingdom;
institutions, representative Australia;
participatory democracy; diffuse Canada; New
decision making institutions; high Zealand
level of state capacity; highly
evolved state based institutions; high
level of public probity; regulatory
reach of the state entrenched
Instrumental Relative high level of political France; Spain; Low to Low to
Non- transparency; political systems Italy Medium Medium
Adaptive displays recurrent crisis of
Systems legitimacy; varying levels of
democratic participation; moderate
to high state capacity; regulatory
reach of state sometimes
compromised

Modernizing Nation-States
System Features Examples Political Political
Type Risk Instability
Instrumental Emergent forms of democratic India; Turkey; Moderate Moderate
and quasi- representation; uneven levels of Mexico;
instrumental democratic participation; circulation Brazil; Czech
systems of, and intense competition between, Republic;
attempting political elites; moderate state Slovakia;
adaptive capacity; regulatory reach of state Russia;

27 | P a g e
politics varies across sectors; varying levels Hungary;
of political transparency; immature Bulgaria;
political legitimacy; political South Korea;
institutions not deeply embedded;
un-coordinated decision making
institutions
Modernizing Centralized power structures; Syria; Jorden Low to Low
Autocracies modernizing elites; low level of moderate
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
Military Autocratic centralization of power; Burma; Central Moderate Moderate
Dictatorships military power used to secure African to High to High
political legitimacy; lawfulness Republic;
secured though force; low political Guinea-Bissau;
participation; centralized Libya
hierarchical decision making
structures; political dissent violently
quashed
Mobilization Centralized command systems; low China; Moderate Low to
Systems levels of political participation; low Vietnam; to High Moderate
levels of political transparency; high Cuba; North
degree of centralized decision Korea; Laos
making; high level of bureaucratic
administration; low level of state
responsiveness; political dissent
quashed
Emergent Newly acquired independence, or East Timor; High Moderate

28 | P a g e
Systems; political systems transiting from Romania; to High
Transition autocratic rule; immature political Indonesia;
States 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

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

29 | 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.

30 | 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.

31 | 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.

32 | 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.

33 | 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.

34 | 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.

35 | 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.

36 | P a g e
Table 1.3: Political Risk: Robock’s Conceptual Framework for Identification and Assessment

Sources of Political Risk Groups through which Political Risk Effects:


political risk can be Types of influence on
generated international business
operations

Competing National Government in power and Confiscation: loss of assets


Philosophies (Nationalism, its operating agencies without compensation; loss
Capitalism, Socialism) of revenue streams

Social unrest and disorder Parliamentary opposition Expropriation with


groups compensation: loss of
freedom to operate; loss of
future profit streams;
implications for share
holder value
Vested interests of local Non-Parliamentary Operation restrictions:
business groups; lobby and opposition groups market shares, product
interest groups; political (guerrilla/ terrorism groups characteristics, employment
activists (environmentalists; operating within or outside policies, locally shared
industry protectionists; of the country) ownership (joint ventures);
national protectionists) foreign ownership
restrictions or ceilings, etc

Recent and impending Non-organized common Loss of transfer freedom:


political independence / interest groups; students, Financial (e.g. dividends,
country transiting to workers, peasants, interest payments), goods,
democracy; political minorities, etc personal or ownership
structures evolving or rights
subject to change

New international alliances; Foreign government or Breaches or unilateral


international organization intergovernmental agencies revisions in contracts and
membership obligations; such as WTO, IMF, EU, or agreements
trade bloc membership / regional forum such as

38 | P a g e
exclusion ASEAN, LAFTA, NAFTA,
APEC; OAS

Foreign governments Discrimination such as


willing to enter into armed taxes, compulsory sub-
conflict or to support contracting; stipulated
internal rebellion 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.

39 | P a g e
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.
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.

41 | 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.

42 | 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

43 | 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.

44 | 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

45 | 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

46 | 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

47 | 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.

48 | 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.

49 | 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.

50 | 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.

51 | 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.

52 | 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.

53 | 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.

54 | 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.

55 | 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.

56 | 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.

57 | 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.

58 | 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.

59 | 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.

60 | 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.

61 | 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.

62 | 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.

63 | 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

64 | 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

65 | 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>

66 | 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

67 | 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.

68 | P a g e