Methods of evaluating political risks custom term papers

Formalization and modeling of macro-political and economic risks have been widely developed in the mid 1970’s. The growth of debts of developing countries has caused the increased interest in so-called risk of insolvency. The specific nature of these risks has led to the need for a systematic analysis of macroeconomic data, although it recognized the need to involve some subjective elements.
A quantitative approach to assessing country risk allows comparing different countries by the degree of risk, using a single numerical risk factor that summarizes the relative influence of a certain number of socio-political factors, through various political and social indicators. The main disadvantage of quantitative methods is the usage of a narrow definition of political risk and concentration on a limited number of risk subpoints, such as political instability, exchange controls and expropriation (Wilkin 2004). However, the full list of potential risks, with different degrees of potential impact on foreign investment, is much broader and includes hundreds of political, economic and socio-cultural factors. Selection of factors and determining their relative weight remains the major problem of quantitative methods (Moran 2007).
Another problem is that the attempt to adapt the quantitative risk metrics for international comparisons encounters the branch/project orientation of most country risks. For example, extractive industries are more vulnerable to expropriation than high-tech manufacturing industry. Moreover, what is regarded as a risk factor for most industries (e.g., political instability) may be a factor of additional opportunities for some other sectors (e.g., the military-industrial complex). Since different countries have different relative levels of risk for different investors, the scope of the quantitative scale of the country risk is shrinking (Wilkin 2004).
For early detection of favorable or unfavorable trends in the country, the method of aggregate statistics is used. On its basis, the two models (PSSI; Ecological Approach) were developed in 1970’s, based on the exact causal relationships and primarily on the econometric data. The model of Political System Stability Index was first described by Handel and West. By measuring directly a series of discrete components of the political and social environment (number of riots, ethno-linguistic fragmentation, effectiveness of legislation, etc.), the model claims to independence from speculative conclusions and distortion. To this end, it introduced additional confidential assessment of indices calculated for each component.
The second model, the so-called “ecological” approach of Knudsen (Knudsen’s Ecological Approach) is based on the assumption that high degree of national frustration will exist in countries with a gap between the expectations of people and their well-being (dynamic concept). Interacting with the visible foreign sector, this frustration may lead to intervention or expropriation, while foreign firms will serve as a scapegoat in the failure of the existing political order to satisfy the economic and political aspirations of the nation (Harms 2002).
The second group of methods includes expert opinions, which are usually the final product of a multistage consultation process. Some of these reports use the econometric evidence, but their main characteristic is a progressive ranking of a large number of countries in accordance with more or less clear logics of analysis. The first company of this kind was the office of BERI (Business Environment Risk Index), which ranks over 50 countries (World Bank 2009; World Investment and Political Risk 2009 2010). Preparation of the ranking of countries by level of risk involves several steps: selection of variables (political stability, degree of economic growth, inflation level, level of nationalization, etc.), the definition of the weight of each variable (the maximum weight is a variable of political stability), processing parameters by the method of Delphi using the expert scale, and determining the total index, theoretically located in the range from 0 to 100 (the minimum index means the maximum risk, and vice versa) (Verheyen 2009). As a rule, codes of countries do not reach the extreme values. custom term paper
Comparative rating systems, using similar methodology, are developed by consulting firms such as Frost & Sullivan (the World Political Risk Forecast, 80 countries), Business International and Data Resources Inc. (Policon). A great step forward was the creation of political data banks (World Handbook of Political and Social Indicators). Other serious rating systems are Institutional Investor’s Country Credit Rating (over 110 countries), and Euromoney’s Country Risk Index (over 115), and International Country Risk Guide (ICRG), covering more than 100 countries (World Investment and Political Risk 2010). Quantitative parameters of the indicators are usually combined with expert opinions and form a complex dynamic model that allows companies to predict the development of national and international economy. The advantage of indicators is their objectivity, and (in most cases) measurability, which allows creating reports of events quickly. However, the major problem is the theoretical foundation of indicators. Another problem is the static character of ratings: they are based on data of past events and conditions that may not have any connection with the future (Wilkin 2004).

Conclusion

Thus, the analysis of internal economic factors gives an overall description of economic development and identifies the most vulnerable areas. The external economic factors determine the degree of influence of external constraints on domestic economic policy: high degree of dependence and large amount of debt increase the risk of government interference in investment activities. The problem of evaluation of internal socio-political factors influencing business in the region lies in a significant proportion of subjectivity. Under certain conditions, the external political environment could play a catalytic role of political instability in the developing country.
Many of the approaches outlined above, highlight the complexity and multidimensional problems of analysis and assessment of political risks. All the models have certain advantages and disadvantages. Expert systems have been criticized for the fact that they are not always clearly tracing causal relationship. Econometric models often suffer from the complexity of current data sources for most of the independent variables required for analysis. Built-in models can be expensive, prolonged in time and geographically limited. This allows concluding that the optimal approach would combine the best aspects of each method and give the opportunity to measure macrorisks and interpret them in relation to project-specific conditions.

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