A Deeper Dive Into Political Risk

By

John F. Phillips, MA

Understanding political risk can be daunting. Not understanding political risk can, in certain situations, can be catastrophic.

That being said, understanding and mitigating political risk isn’t rocket science. In many cases, it is about understanding the political arena and reacting to events and trends. If done properly and as part of an overall risk management strategy, understanding and mitigating political risk is a process that is time well spent.

In a previous piece, I spoke about the importance of engaging in political risk analysis and mitigation and listed some aspects of political risk that could positively or negatively impact the decision making process. Let’s take a look at some political risk categories and think about some of the questions that might arise when evaluating that specific political risk.

Election Results

We often hear from those in politics that elections have consequences. The outcome of an election can have serious consequences in so many areas and it’s important to understand the questions surrounding changes brought about by these outcomes.

Here are some questions that should be considered when thinking about election outcomes:

  • What political party now controls the government (not always obvious)?
  • Does that party control all branches of the government or does it exercise partial control?
  • What is the governing philosophy of the party in control (pro or anti business, pro or anti regulation, big or small government, etc.)?
  • Does the party in control have to form a coalition with other parties in order to exercise power (level of compromise in the American two party system)?
  • What amount of influence do coalition partners exercise in the formulation of policy?
  • How does the influence of coalition partners or opposition parties impact decision making or the ability to enact legislation?
  • How hyper-partisan is the political system and how does that impact policy making and compromise in the legislative process? Is bipartisan or multi-party consensus possible?

Leadership Succession in Political Parties

Leadership succession in political parties is an important factor in evaluating political risk because leadership succession can be a messy business. In the United States, former president Donald Trump still exercises iron grip like control over the Republican party despite the fact that he lost his bid for a second term to President Joes Biden by a considerable margin. Republicans also lost its majority control of the Senate, and are in the minority in the House of Representatives, with some Republicans blaming Mr. Trump for these setbacks at the ballot box . Despite these setbacks, Mr. Trump’s influence still exerts almost absolute power over the party and will continue to do so in the foreseeable future despite the presence of a more centrist faction in the party that wants to move on from Mr. Trump and Trumpism.

In Germany, Angela Merkel will soon turn over the leadership reins of the Christian Democratic Union (CDU), the majority party in the governing political coalition and a party she has led for almost twenty years. While she has handed over leadership in the party, she is still head of the government and her departure will impact events not only in Germany, but also in the EU. A critical issue will be the level of political/ economic instability that is created as the leadership transition plays out.

Here are some questions that might be asked when assessing political risk in this area:

  • Who might be the new leader of the political party in question (again, not always obvious)?
  • Does this leader exercise total control over the direction of the party or does power rest with others within the party?
  • If a leadership change is occurring, is there a clear favorite to take over the leadership position or will succession be a political brawl?
  • How well is the new leader known?
  • If a leadership change is needed or desired, how entrenched is the current leader and what level of control does that leader exercise over the leadership change process (think leadership succession in the former Soviet Union)? Is change possible in the short or intermediate time horizon?
  • Is leadership change mean that the philosophy or governing approach of the party changes or remains the same? If change is indicated, to what degree will change occur and at what tempo?

Political Factors Driving Economic Policy

Economic issues have a significant impact on the assessment of political risk. One way to think about politics is that it is the struggle for the allocation of resources in a society, in other words, who gets what. Like an election, this is a zero sum game and defines winners and losers and establishes priorities.

History has shown that struggles over economics have brought about the downfall of entire political systems and the demise of empires (British Empire, Soviet Union and its eastern European empire). I love this example. During the 1980s political/economic upheaval that led to the downfall of communism in Poland and, ultimately, the Soviet Union, a Polish worker reacted to government economic reforms by sarcastically stating, “the times are past that they closed our mouths with sausage.” (George Weigel, The End and The Beginning: Pope John Paul II- The Victory of Freedom, the Last Years, the Legacy; 2010. p. 118) We know how well that worked out and how the story ultimately ended!

The point is, politics and economics are intimately intermingled and one ignores political risk with respect to economic policy at their own peril.

Below are some questions that need answering when assessing the impact of political risk on economic policy:

  • What economic system (capitalism, socialism, communism, a hybrid, none of the above) is exercised in the country in question?
  • Will political outcomes impact the system currently being used to manage the economy?
  • To what extent does the political situation in a country impact government economic policy? Does it restrict or open markets? Does it encourage innovation?
  • Is a country isolationist, globalist, or somewhere in between and how does that impact political decision making with respect to economic policy, specifically trade policy?
  • How open is the country in question to Direct Foreign Investment (DFI) and other similar economic development strategies?
  • What is the governing philosophy concerning government intervention in the economy, especially in times of political or economic instability (this can be a big problem in developing economies, in countries that have a history of government instability, or in times of crisis)?
  • How does the government approach tax and regulatory policy (big versus small government)?
  • What is the level of corruption, particularly in the bureaucracy, and how does that impact political behavior ?

Obviously, these lists are not all inclusive by any stretch of the imagination. The point is, political risk is pervasive and can impact all aspects of decision making, often in ways that aren’t expected. For example, who would have thought that the US government, a government that encourages and supports relatively open markets, would have implemented wage and price controls during the 1970’s in order to deal with an unstable economy or injected massive amounts of money to stabilize the banking and finance sector and credit markets, as well as bailing out the auto industry, during the Great Recession?

Again, understanding and mitigating political risk is a really big deal.

My hope for you after reading this is that you are better informed about political risk and will begin to take steps to integrate an understanding of the impact of political risk into your thought process. I’m here to help in any way that I can.

Is understanding political risk part of your information gathering process?

Do you or your organization integrate political risk mitigation into your strategic planning process? Why or why not?

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