Chapter overview
Chapter 1: Introduction
Political risk events often exhibit "fat tails" in probability distributions, where most events occur in the middle. Fat tails refer to the unexpectedly large likelihood of events at the extremes of the distribution curve. These represent the risk of seemingly improbable and difficult-to-predict events that are often overlooked. However, these unlikely political risk events occur more frequently than anticipated, making it essential for corporations, policymakers, and investors to understand and manage them. While some may consider political risk too complex and unpredictable to address, the book argues that it can be effectively managed through proper understanding.
Chapter 2: Dealing with Uncertainty
Uncertainty implies an ignorance of the probability or impact (or both) of an event. The objective of risk management is to enable the determination of these factors so that what is uncertain becomes a measurable risk. Political risk is primarily measurable because politically motivated events usually require planning and deliberation. Additionally, understanding the preferences and constraints of a political system and its actors enables the forecasting of political risks. Risk maps, challenging basis assumptions through contrarian thinking, scenario analysis, and assessing country stability are valuable methods for understanding and forecasting political risk explored in this chapter.
Chapter 3: Geopolitics
Geopolitical risk affects financial markets, corporate activity, and governments. These risks are more difficult to analyze because of their long duration, analytical bias, and the complexity of feedback loops and interacting risks. The first step in analyzing geopolitical risks is identifying risks through information gathering and early warning systems. Processing and analyzing this information correctly requires using different analytical frameworks and theories. Companies can mitigate geopolitical risks by keeping an open mind, having a nimble organizational structure, planning for vastly different scenarios, and purchasing political risk insurance.
Chapter 4: Political Risk and Capital Markets
Politics and government policies can profoundly impact capital markets through currency controls, financial regulatory changes, sovereign credit defaults, and corruption, among other things. However, most investors fail to incorporate political risk into their economic models, reducing the efficacy of their models and heightening the potential for financial losses. Political risk is especially important to consider when investing in emerging markets: by definition, Eurasia Group argues these are countries where politics matters at least as much as economics in affecting market outcomes. Each emerging market is unique—based on its regime type, ideology, policies, electoral systems, etc.—and thus political risk analysis varies for each country.
Chapter 5: Domestic Instability—Revolution, Civil War, State Failure
Domestic instability can negatively affect investors and corporations, such as during the 1979 Iranian Revolution. Methods of analyzing domestic instability include aggregating indicators associated with political unrest and closely monitoring a country’s cities and/or youth population. One type of domestic instability is civil strife, which is a societal—as opposed to a governmental—risk. Civil strife includes revolutions, wars, state failures, coup d’états, and riots. Companies can mitigate the risks of civil strife through risk absorption, transfer, pooling, diversification, or avoidance.
Chapter 6: Terrorism
To mitigate the risks of political terrorism, it is helpful to map the terrorist groups and their goals, tactics, and membership. This complex undertaking requires an understanding of the environment in which terrorists operate and their organizational structure. Corporations and financial institutions can incorporate planning for terrorist attacks into their planning for events such as building damage, utility failures, and threats to their employees. Governments can attempt to prevent terrorist attacks through policing, military action, or accommodating terrorists’ demands. Given the diverse nature of terrorist groups, a varied approach to mitigating the risk of terrorism is required.
Chapter 7: Expropriation
Although the number of expropriations has declined since the 1970s, the value of the expropriations that do occur remains high. The global investment environment has become more complex as governments have become more sophisticated at restricting private property rights through regulatory changes and “creeping expropriations.” The ability and willingness of a government to expropriate is a function of international politics, economic resources, ideology, domestic politics, and—often most importantly—nationalism. Expropriation risk can be mitigated by spreading the risk among various stakeholders, engaging in joint ventures with a domestic partner, financing the investment to discourage the government from expropriation, and obtaining insurance and/or legal protection.
Chapter 8: Regulatory Risk
Governments may use their regulatory systems to discriminate against foreign investors and multinational corporations for various reasons- including fears about fading national identity and corruption. Analysis of regulatory risks must consider the government's political orientation, the strength and autonomy of local regulatory institutions, domestic politics, and the government’s relationship with domestic businesses. Risk mitigation strategies include partnering with a local business or government and obtaining financing from an influential global investor. Regulatory risk varies by sector: some face relatively more pervasive regulations, while others are inherently more flexible and better able to mitigate regulatory risks and costs.
Chapter 9: Reporting and Warning
Identifying and analyzing a risk are not sufficient for risk mitigation—a decision-maker must also understand the risk and be able to take action. Many types of biases can inhibit the successful acknowledgment of and the appropriate mitigating action of risk, including organizational/bureaucratic biases, cultural/ideological biases, and cognitive biases. Another issue in ensuring that political risks are understood is tailoring the reporting of these risks to the audience, whether it is corporate managers, financial investors, or government policymakers.
Conclusion: Mitigating Political Risks in an Uncertain World
There are four main strategies to reduce the probability of a risk event: eliminate the threat, minimize its likelihood, isolate the event, or altogether avoid the risk. None of these strategies are perfect, so planning to mitigate the impact after a risk occurs is also necessary. A holistic approach to risk management—such as Enterprise Risk Management (ERM)—breaks down categories of risks and standardizes their analysis. However, many corporations fail to incorporate political risks into their risk management frameworks, either because they do not recognize the importance of political risks or because they mistakenly think political risks are unpredictable. However, political risks are knowable—in some cases, even quantifiable—and understanding these risks is the first step in successful political risk mitigation.
